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

1. Korea's Economic Success: Strategies, Challenges, and Lessons for Mongolia Choongsoo Kim Governor The Bank of Korea August 15, 2011

2. Contents Ⅰ Introduction Ⅱ Korea's Economic Development Ⅲ Overcoming Financial Crises: Korea's Choice Ⅳ G20 Korea Initiatives Ⅴ Implications for Mongolia of Korea’s Success

3. Ⅰ Introduction Snapshot of Korea’s Success Purposes of Today’s Lecture

4. Modernization (1): Past vs Present The same place, 60 years apart Gangnam 2010 Gangnam circa 1950s

5. Modernization (2): Past vs Present The same place, 60 years apart Cheonggyecheon 2010 Cheonggyecheon circa 1950s

6. Industrialization: from low-tech to high-tech Electronics factory 2010 Typical apparel factory circa 1960s

7. Bumpy Road but Steady Course to Democracy Advancedto democracy Present Protest against despot circa 1980s

8. Financial crises: 1997 vs 2008 1997 crisis 2008 global crisis

9. Development Outcomes 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)

10. Sustained Growth but not without Difficulties GDP growth rate (quarterly, YoY) 2nd Oil Shock 2008 Crisis 1997 Crisis

11. Quick Recovery from the Global Financial Crisis GDP growth rate (quarterly, YoY) (%) Korea (t=1997 Q4) Korea (t=2008 Q3)

12. 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

13. Ⅱ Korea's Economic Development • Brief Historical Overview • Contributing Factors to Korea's Economic Success

14. Post-war reconstruction: 1945 through 1950s Development Goals: Curbing hyper-inflation (peaked in 1951 at over 390%) Postwar reconstruction Restoring 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)

15. Export-driven Industrialization: 1960s through 1970s Switch in economic development strategy Key rationales: Need to resolve the balance of payments problems following reduced foreign aid Import substitution for non-durables almost completed Shortage of natural resources → Exports considered only as means to achieve economic development Import Substitution + Priority on Stability Export-driven + Priority on Growth

16. Export-driven Industrialization: 1960s through 1970s (continued) Five-Year Economic Development Plans (1stplan in 1962, six plans in total) Served as catalyst for “economic miracle” Blueprint of government-led resource allocation in the absence of well-functioning markets Helped improve policy continuity and flexibility over a long horizon

17. Economic Stabilization and Liberalization: 1980s through Mid 1990s Swift transition in economic development strategy to address growing 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 indicativeplanning Government: strategic vision Private sector: specific actions Private Sector-driven + Stability Enhancement Government-led + Growth Promotion

18. 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

19. Economic Stabilization and Liberalization: 1980s through Mid 1990s (continued) Inflation 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 • Current account balance, Fiscal balance

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

21. Financial Integration and Economic Reform: Late 1990s through Present Two financial crises Witnessed danger of ill-prepared financial integration (1997 crisis) 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 policies

22. Contributing Factors to Korea's Economic Success Outward-looking Development Strategy Flexible Adaptation of Economic Policies Emphasis on Market Principles

23. Outward-looking Development Strategy Reap the benefits of open economy: Efficiently utilize changes in external environment Strengthen competitiveness through global competition Take advantage of economies of scale Minimize government failure and prevent corruption by market 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 policies Market opening being the most effective way to upgrade the economy to an advanced level

24. 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 countries of large difference in size and development stage

25. Flexible Adaptation of Economic Policies Import substitution (1950s) Export promotion (since the 1960s) Light industryorientation (1960s) Heavy and chemical industry orientation (1970s) Growth-acceleration/poverty reduction (1960s-70s) Sustainable growth with durable stability (since the 1980s) Financial deregulation (since the 1980s) Financial suppression (1950s-70s) Government-led growth (1960s-70s) Private sector-led growth (since the 1980s, particularly after the 1997 crisis) Capital account controls (1950s-80s) Capital account liberalization (since the early 1990s)

26. 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

27. Ⅲ Overcoming Financial Crises: Korea's Choice • Financial Crisis of 1997 • Global Financial Crisis of 2008

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 GDP growth rate(quarterly, YoY), Unemployment rate 1997 Crisis 2008 Crisis 2008 Crisis 1997 Crisis

30. Comparing the 1997 Crisis and the 2008 Crisis < 1997 crisis > Contagion from Southeast Asian crisis IMF rescue package + Government-led restructuring Increased vulnerability to external shocks Accumulated structural weakness Massive capital outflow Failures of big companies + Ill-sequenced capital account liberalization Heavy reliance on external debt Inadequate foreign reserves Denied rollover of short-term external debt Collapse of investor confidence Overvalued FX rate CA deficits Debt-ridden corporate sector Lax risk management Unprecented monetary tightening Financial and coporate restructuring Fiscal backing

31. Comparing the 1997 Crisis and the 2008 Crisis IMF support ? No, not this time < 2008 Global Crisis > Deleveraging Flight to quality Capital outflow Jittery financial market Sufficient policy space Quick recovery + Macroprudential reform Collapsing global demand Export ↓ Growth ↓ Global imbalances Housing bubble in advanced countries Subprime crisis Counter-cyclical macro policies Flexible FX rates Ample liquidity buffer + SWAP with the Fed Growth rebounded by 2009 Bank levy Procyclicality of capital flows High trade linkage to advanced countries

32. G20 • Development Issue • Global Financial Safety Nets IV G20 Korea Initiatives

33. G20 meetings

34. Basic Facts about the G20 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) Economic weight* of G7 and EMEs (%)

35. Korea Initiatives at the G20 Development Issue Global Financial Safety Nets

36. Korea Initiatives at the G20 Development Issue Focus on shared growth for all countries ‘Seoul Development Consensus for Shared Growth’ helps developing 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.

37. Korea Initiatives: Global Financial Safety Nets (GFSNs) Global crisis reveals a number of shortcomings in the international 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) Volatility jumped in times of crisis Exchange rate Volatility Ever-increasing self-insurance? Foreign Reserves/GDP (%)

39. Korea Initiatives: GFSNs (concluded) Progress made 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 assistance Regional level: regional financing arrangements Bilateral level: swap lines between central banks To be pursued along with other G20 agendas (e.g., reducing global imbalances, financial regulatory reform) • Going forward

40. V Implications for Mongolia of Korea’s Success • My Understanding of the Mongolian Economy • Implications of Korea’s Success

41. Close Ties between Mongolia and Korea Mongolia Korea

42. My Understanding of the Mongolian Economy 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 abundant natural resources Vulnerable to commodity booms and busts Need to develop non-mineral sector for sustained growth Need to strengthen macroeconomic stability

43. Mongolian Economy (continued)

44. Mongolian Economy (concluded)

45. Implications of Korea’s Success

46. (1) Tailored Development Strategy 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.)

47. (2) Investment is Key Sustained and efficient investment is key to growth and development. Investment is the most reliable and robust explanatory variable in growth regressions. Public investment could play a catalytic role in promoting private investment. SOC investment is crucial for growth take-off while education investment is essential for sustained growth.

48. SOC Investment in Korea 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

49. Example: Seoul-Busan Expressway (1968-70) The main expressway that connects Korea’s two largest cities and other industrial hubs

50. Example: Seoul-Busan Expressway (continued) Background Explosive increase in passenger and cargo transportation amid rapid industrialization Forward looking investment plan with long-term perspective ` Financing 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)