Korea's Economic Success: Strategies,Challenges, and Lessons for Mongolia

Choongsoo Kim

GovernorThe Bank of Korea

August 15, 2011

Contents

IntroductionⅠ

Korea's Economic Development Ⅱ

Overcoming Financial Crises: Korea's Choice Ⅲ

G20 Korea InitiativesⅣ

Ⅴ

2

Implications for Mongolia of Korea’s Success

Snapshot of Korea’s Success

Purposes of Today’s Lecture

3

IntroductionⅠ

4

Modernization (1): Past vs Present

The same place, 60 years apart

Gangnam circa 1950s

Gangnam 2010

5

Modernization (2): Past vs Present

The same place, 60 years apart

Cheonggyecheon circa 1950s

Cheonggyecheon 2010

6

Industrialization: from low-tech to high-tech

Typical apparel factory circa 1960s

Electronics factory 2010

7

Bumpy Road but Steady Course to Democracy

Protest against despotcirca 1980s

Advanced to democracyPresent

8

Financial crises: 1997 vs 2008

1997 crisis 2008 global crisis

9

Per capita Income: US$ 82 (1961) → US$ 20,759 (2010)

Size of GDP: US$ 2.1 bil. (1961) → over US$ 1 trillion (2010)

Joined the OECD (1996)

Joined the OECD’s Development Assistance Committee (2009)

Hosted the G20 Summit (2010)

Development Outcomes

10

Sustained Growth but not without Difficulties

GDP growth rate (quarterly, YoY)

2nd Oil Shock

1997 Crisis

2008 Crisis

Quick Recovery from the Global Financial Crisis

11

GDP growth rate (quarterly, YoY) (%)

Korea (t=1997 Q4)

Korea (t=2008 Q3)

Purposes of Today’s Lecture

To share Korea’s experiences in economic development and crisis management

To explain how such experiences were reflected in ‘Korea Initiatives’ at G20 meetings of 2010 To draw implications for Mongolia of Korea’s economic development

model

12

Brief Historical Overview

Contributing Factors to Korea's Economic Success

13

Korea's Economic Development Ⅱ

Post-war reconstruction: 1945 through 1950s

14

Development Goals:

Curbing hyper-inflation (peaked in 1951 at over 390%)Postwar reconstructionRestoring political and social stability

Targeting import substitution cum fiscal austerity Foreign aid-dependent economic management → Limited tangible outcomes with only moderate economic growth (Average annual growth rate was 3.8% during 1953-1960)

Switch in economic development strategy

Key rationales:

Need to resolve the balance of payments problems follow-ing reduced foreign aid

Import substitution for non-durables almost completed

Shortage of natural resources

→ Exports considered only as means to achieve economic development

15

Import Substitution +Priority on Stability

Import Substitution +Priority on Stability

Export-driven +Priority on Growth

Export-driven +Priority on Growth

Export-driven Industrialization: 1960s through 1970s

Export-driven Industrialization: 1960s through 1970s (continued)

Five-Year Economic Development Plans (1st plan in 1962, six plans in total)

Served as catalyst for “economic miracle”

Blueprint of government-led resource allocation in the ab-sence of well-functioning markets

Helped improve policy continuity and flexibility over a long horizon

16

Economic Stabilization and Liberalization: 1980s through Mid 1990s

Swift transition in economic development strategy to address grow-ing macroeconomic imbalance

High inflation rate (CPI 29%, PPI 39% in 1980)

Burgeoning fiscal deficit: 1.4% of GDP in 1979 → 4.5% in 1981

Worsening CA deficit: 2% of GDP in 1978 → 8.3% in 1980

From state-led planning to indicative planning

Government: strategic vision

Private sector: specific actions17

Government-led +Growth Promotion

Government-led +Growth Promotion

Private Sector-driven +Stability Enhancement

Private Sector-driven +Stability Enhancement

Economic Stabilization and Liberalization: 1980s through Mid 1990s (continued)

Stabilization Policies:

Monetary and fiscal tightening (cold turkey)

Domestic deregulation

Trade liberalization

Income policy (e.g., forward looking wage contracts)

Policy credibility earned by delivery of targeted outcomes

18

Outcomes:

Inflation rate (CPI): 29% in 1980 → 2.3% in 1984

Fiscal balance: -4.3% of GDP in 1981 → +0.2% in 1987

CA balance: -8.3% of GDP in 1980 → +4.1% in 1986

19

Economic Stabilization and Liberalization: 1980s through Mid 1990s (continued)

Current account balance, Fiscal balanceInflation

Albeit successful stabilization, vulnerability to external shocks remained

Heavy reliance on external demand

(export + equipment investment)/GDP ratio: 32.1% in 70s → 42.5% in 80s → 36.2% during 1990-96

Debt-ridden corporate sector

Debt-to-equity ratio: 336% in 1996

Increased exposure to foreign capital flows

Shortening of external debt maturity

Short-term debt-to-total external debt ratio: 50% in 1996

20

Economic Stabilization and Liberalization: 1980s through Mid 1990s (concluded)

Financial Integration and Economic Reform: Late 1990s through Present

Two financial crises

Witnessed danger of ill-prepared financial integration (1997 cri-sis)

Triggered comprehensive reform

1997 crisis

Rooted at domestic structural vulnerability

Followed by major restructuring and financial opening

2008 global crisis

Exogenous shock beyond domestic control

Revealed shortcomings of the current international monetary system

Korea Initiatives at G20 for global solution

Strengthening of macroprudential policies21

22

Outward-looking Development Strategy

Flexible Adaptation of Economic Policies

Emphasis on Market Principles

Contributing Factors to Korea's Economic Success

Outward-looking Development Strategy

 

23

Reap the benefits of open economy:

Efficiently utilize changes in external environment Strengthen competitiveness through global competitionTake advantage of economies of scaleMinimize government failure and prevent corruption by mar-

ket discipline (imported through exports)

But constantly exposed to external shocks and spill-over risks,both financial and real

Took challenges posed by the risks by pursuing further market opening and reform, in view of:

Those risks being manageable with prudent policiesMarket opening being the most effective way to upgrade the economy to an advanced level

Outward-looking Development Strategy (continued)

Korea signed FTAs with the EU and the US*.

* waiting for ratification Significance: 

Show Korea’s firm commitment to free trade  

Help fight against the specter of protectionism at this critical juncture

 

Provide an exemplary case for cooperation between coun-tries of large difference in size and development stage 

24

Flexible Adaptation of Economic Policies

25

Import substitution (1950s)Import substitution (1950s)

Light industry orientation (1960s)Light industry orientation (1960s)

Growth-acceleration/poverty reduction (1960s-70s)

Growth-acceleration/poverty reduction (1960s-70s)

Financial suppression (1950s-70s)Financial suppression (1950s-70s)

Government-led growth (1960s-70s)Government-led growth (1960s-70s)

Capital account controls (1950s-80s)Capital account controls (1950s-80s)

Export promotion (since the 1960s)Export promotion (since the 1960s)

Heavy and chemical industry orientation(1970s)

Heavy and chemical industry orientation(1970s)

Sustainable growth with durable stability(since the 1980s)

Sustainable growth with durable stability(since the 1980s)

Financial deregulation(since the 1980s)

Financial deregulation(since the 1980s)

Private sector-led growth (since the 1980s, particularly after the 1997 crisis)

Private sector-led growth (since the 1980s, particularly after the 1997 crisis)

Capital account liberalization (since the early 1990s)

Capital account liberalization (since the early 1990s)

Emphasis on Market Principles

Steady transition from government-led to market-driven economy through liberalization

Upheld market principles even under government-led growth (e.g., indicative planning)

‘Strong will to economize’ interacted with tangible economic success

Entrepreneurship enabled firms to take risks for returns and lead technology development

Forward looking patience induced households to save and learn more for the future (Confucian ideology)

Government invested in education, and encouraged private investment through partial risk-sharing and tax incentives

26

Financial Crisis of 1997

Global Financial Crisis of 2008

27

Overcoming Financial Crises: Korea's Choice Ⅲ

28

Comparing the 1997 Crisis and the 2008 Crisis

Stock price, Interest rate Exchange rate, Capital inflow*

1997 Crisis

2008 Crisis

1997 Crisis

2008 Crisis

* Changes in liabilities including portfolio investment, financial derivatives and other investment

29

Comparing the 1997 Crisis and the 2008 Crisis

CA/GDP, International reserves

1997 Crisis

2008 Crisis

1997 Crisis

2008 Crisis

GDP growth rate(quarterly, YoY), Unemployment rate

Accumulated structural weakness

Massive capital outflow Failures of big companies

30

Contagion from Southeast Asian crisis

Contagion from Southeast Asian crisis

IMF rescue package

+Government-led

restructuring

IMF rescue package

+Government-led

restructuring

< 1997 crisis >

Ill-sequenced capital account liberalization

Heavy reliance on external debt

Inadequate foreign reserves

Denied rollover of short-term external debt

Collapse of investor confidence

Unprecented monetary tightening

Financial and coporate restructuring

Fiscal backing

Overvalued FX rate

CA deficits

Debt-ridden corporate sector

Lax risk management

Increased vulnerability to external shocks

+

Comparing the 1997 Crisis and the 2008 Crisis

DeleveragingFlight to quality

IMF support ?

No, not this time

31

Sufficientpolicy space

Sufficientpolicy space

< 2008 Global Crisis >

Comparing the 1997 Crisis and the 2008 Crisis

Procyclicality of capital flows

High trade linkage to advanced countries

Global imbalances

Housing bubble in advanced countries

Subprime crisis

Counter-cyclical macro policies

Flexible FX rates

Ample liquidity buffer + SWAP with the Fed

Capital outflowJittery financial market

Collapsingglobal demand

Export ↓Growth ↓

Quickrecovery

+Macroprudential

reform

Quickrecovery

+Macroprudential

reform

Growth rebounded by 2009

Bank levy

32

G20

Development Issue

Global Financial Safety Nets

G20 Korea InitiativesIV

33

G20 meetings

Formed in 1999

G7 + 12 EMEs* + EU

* Argentina, Australia, Brazil, China, India, Indonesia, Korea, Mexico, Russia, Saudi Arabia, South Africa, Turkey

Account for 85% of world GDP

* share in world GDP

Emerged as a premier forum for global economic issues

* First summit meeting in Nov. 2008 (ministerial meeting until 2007)

Basic Facts about the G20

34

Economic weight* of G7 and EMEs(%)

35

Korea Initiatives at the G20

Development Issue

Global Financial Safety Nets

Korea Initiatives at the G20

36

Focus on shared growth for all countries

‘Seoul Development Consensus for Shared Growth’ helps devel-oping countries increase their capacity rather than providing more financial aid.

* Korea has been running “Knowledge Sharing Program” since 2004

Discussing Development Issue helps strengthen legitimacy of G20.

Development Issue

Korea Initiatives: Global Financial Safety Nets (GFSNs)

37

Global crisis reveals a number of shortcomings in the interna-tional monetary system including:

Absence or malfunctioning of international adjustment mechanism to correct global imbalances

Under-regulated capital flows often resulting in booms & busts

Heightened volatility in major exchange rates

Financial interconnectedness amplified and propagated shocks quickly around globe to affect innocent bystanders

Not only emerging but also advanced economies need financial safety nets

GFSNs should be more efficient than self-insurance (i.e., risk-pooling)

38

Korea Initiatives: GFSNs (continued)

Exchange rate Volatility

Volatility jumped in times of crisis

Ever-increasing self-insurance?Foreign Reserves/GDP(%)

Enhanced liquidity provision by the IMF (Flexible Credit Line + Precautionary Credit Line)

  

Need to construct a multi-layered network for certain, sufficient, stigma-free liquidity support while minimizing moral hazard

Global level: IMF assistanceRegional level: regional financing arrangementsBilateral level: swap lines between central banks

To be pursued along with other G20 agendas (e.g., reducing global imbalances, financial regulatory reform)

39

Progress made

Korea Initiatives: GFSNs (concluded)

Going forward

40

Implications for Mongolia of Korea’s Success V

My Understanding of the Mongolian Economy

Implications of Korea’s Success

41

Close Ties between Mongolia and Korea

Mongolia Korea

My Understanding of the Mongolian Economy

42

Transition to a market economy since 1990s, rapidly overcoming initial economic and political difficulties and global financial crisis Geographically land-locked but high growth potential due to abun-dant natural resources

Vulnerable to commodity booms and busts

Need to develop non-mineral sector for sustained growth

Need to strengthen macroeconomic stability

Mongolian Economy (continued)

43

Mongolian Economy (concluded)

44

45

Implications of Korea’s Success

Upheld key principles such as efficiency, openness, long-term planning, and flexibility in designing development strategy

But also tailor development strategy to country’s circumstances

Best utilize country’s comparative advantages (e.g., natural

resources, large land area, natural heritage for tourism etc.)

Be mindful of constraints and weaknesses (e.g., volatility of

commodity prices, weak fiscal stability, underdeveloped non-

mineral sector, etc.)

46

(1) Tailored Development Strategy

Sustained and efficient investment is key to growth and development.

Investment is the most reliable and robust explanatory vari-able in growth regressions. Public investment could play a catalytic role in promoting private investment.

SOC investment is crucial for growth take-off while educa-tion investment is essential for sustained growth.

47

(2) Investment is Key

Large and sustained public investments in SOC

Investments were initially targeted to growth-hub regions for maximum efficiency before being diversified in the 1980s and 1990s for more balanced regional development.

Investments guided by medium-term Economic Development Plans to ensure continuity and minimize uncertainty

Public-private partnership (PPP) actively utilized in the 2000s to promote efficiency and tap into large private resources for

financing

48

SOC Investment in Korea

Example: Seoul-Busan Expressway (1968-70)

49

The main expressway that connects Korea’s two largest cities and other industrial hubs

Example: Seoul-Busan Expressway (continued)

50

Background

`

Failed to secure financing from World Bank, which rejected funding based on cost-benefit analysis

Turned to domestic funding (including reparation fund from Japan)

* total cost: 42 billion won (16% of annual government budget)

Financing

Forward looking investment plan with long-term perspective

Explosive increase in passenger and cargo transportation amid rapid industrialization

Example: Seoul-Busan Expressway (concluded)

51

Revolutionized distribution and transportation network Contributed to regional development and export competitiveness

Set the stage for development of construction and auto industries

Facilitated external funding for subsequent major construction projects (e.g., World Bank changed its view and granted loans for the ensuing construction projects)

Results

52

(3) Outward-looking Strategy

Nonrenewable commodity exports are the main driver of growth in Mongolia at present but cannot be sustained.

Limited base for domestic demand due to small population Development of the non-mineral sector may first target domestic demand but should ultimately be guided by export orientation

Geographic proximity to two large countries—China and Russia—could be attraction for FDI

Preserving policy space and flexibility is critical for economic and fi-nancial stability against external shocks.

Mongolia’s heavy dependence on volatile commodity exports puts particularly high premium on policy space.

Fiscal policy should play a major stabilization role in commodity ex-porters, including managing national wealth for consumption smoothing across generations (e.g., Sovereign Wealth Fund)

Saving windfall gains from commodity booms could help avoid the so-called ‘resource curse’.

Monetary policy geared toward price stability under flexible FX regime with due consideration on FX liquidity (foreign reserves)

(4) Preserving Policy Space and Flexibility

53

Maximize the benefits of integration while minimizing the attendant risk

Appropriate sequencing is essential: trade integration first, followed by steady but gradual (and well prepared) financial integra-tion

Continuously upgrade domestic institutions for financial regula-tion, trade, and foreign investment

Adapting to new global economic and financial order emerg-ing after the global financial crisis

(5) Integration into Global Economy

54

Thank You!