RESTRICTED F"RETURN TO - -1 Report No. FE- 55 |REPORTS DESNI I W1ITF4;" | This report was prepared for use within the Bank and its affilioted organizations. Thy Uo hiur waLpt respUnsoiiiry oIUr it ULLUr[UY or LUcTIpIetenIes. IFICe repUrI FFIUy not be published nor may it be quoted as representing their views. TXVTT'TnXT A 'TrtC'%xT A T t A 1.XTV 0(r:1 D ThTDTTcTrT A kTTh Th1-'1 T r T'fT-.XTT TXT'Trl-nXT X 'TT/r.T A T T'~YCWT r(T7X1r'XT?r A CO-tI A 'rTtf%)kT L.N I LZL8l N1l I.t 11%L.. 1JL. V L 1I I L J. Il'iN THE ECONOMY OF KOREA (in eight volumes) VOLUME I MAIN REPOR.T June 1]7, 1966 Far East Department ClJRRENCY EQUIVALENTS U.S. $1.00 Won 270 Won 1, 000 U.S. $3. 70 Won 1, (00, 000 U.S. $3, 703. 70 This repor+. is based. nn the findings of a :1issinn which visited Korea in November and December, of l965. The Irission was com.posed of the following members: D- * Tr. -1ha+ -h Cornelis J. A. Jansen General Economist UOkDaly Yenal" liny& >liF;a^ Alexander Nowicki Industry M. Shafi Niaz (FAO) Agriculture W. F. Doucet (FAG) Fisheries Robert Ward (Arthur D. Little) Lndustry Remedios Crofoot Secretary m&LSIC DATA Page No. MAP OF KOREii SUIfiiRY AND COiVCLUSIONS ... . . ... i - vi I. Introduction .................... ** 1 TT. Tnvestment, OutDut and Emiployment 7195,,-1965) ............................ v A. hIacro-Ec.onomic Picture ............ 5 B. Dynamics of Agriculture O. 10 C. The Role of IManufacturing 13 D. Fisheries: A Backward Sector 18 E. Electric Power: A Bottleneck Removed . 20 F. The Transport Netuork ........ 22 III. Public Sav^%ii4s, PrRivate Sangs and Foreign Aid (1955-1965) *..'..... .. 25 A. The Overall Perspective. 25 B. Public Savings .. ....... 26 C. Private Savings and Inflation 29 D. Foreign Resources ............. 32 IV Imoort Substitution anJ Growth In Exports 35 A. The Exchange Rate Policy ..35 B. Phenomenal Growth in Exports ...... 37 C. Behavior of Imports .4......1...... 4 V. The Tentative Framework of the Second Five-Year Plan ..... * ....... ...... * .... 44 A. The Nature of the Plannimng Process 44 B. The llacro-Economic Framework ...... 45 C. Reduction in Population Growth 46 D. Feasible Growth in Income ......... 47 TABLE OF CONTENTS (Cont.) Page No. E^ Domestic Resource Mobilization .... 49 F. Foreian Resources and Investment Requirements .... . . .. .... 53 VI. Preliminary Sectoral Explorations .. .... 54 A. The Overall View .........-........ 5 B. Prospects for Agriculture ...... o... 56 Land Reclamation .... oo ...... o .... 56 Measures for Yield Improvement .... 58 Cropping Pattern .. .......o.. 60 Subsidies, Credit and Tenancy ..... 61 C. Prospects for Fisheries ... ....... 62 D. Prospects for iM4anufacturing .... o.. 64 Investment Good Industries ........ 65 Intermediate Goods Industries ..... 70 Consumer Goods Industries ......... 74 E. Need for Transport Investment ..... F. Program for Electric Power 78 VII. Outlook for the Balance of Payments .... 81 A. Assessment of Export Potential .... 81 B. Invisibles and Merchandise Imports. 89 C. The Iiagnitude and Pattern of Future Foreign Capital Inflow ....90 D. Terms of Foreign Assistance 91 List of Tables ....... . . . . .-.. . .. . .. .. . List of Chables .......0................. 0........... LIST OF TABLES Page No. Table No. 1 Past Trends in Investment, --ployment arnd Value Added .................................. 6 2 The Dimensions of Growth in Agricultural Output, Yields and Area .. .................... 3 Growth Rates and Composition of Output in Manufacturing ....... ......................... 14 4 Power Consumption and Capacity .... ............ 21 5 The Financing of the Current Account Deficit .. 33 6 Growth and Structure of Exports .... ........... 39 7 Composition of Imports and Pattern of Import Substit,ution ................................. 42 8 Net Foreign Resource Requirement 1967-71 ...... 48 9 Proposed Macro-Economic Framework 1966-1971 ... 51 10 Agricultural Investment and Production Targets 57 11 Comparison of Yields Per Hectare .... ........ 59 12 Fisheri.es: Investment & Production Outlook 63 13 Lines of Expansion in Manufacturing .......... 66 14 Forecast of Steel Demand ..... ................ 68 15 Demand Projection for Petroleum Products 71 16 Proposed Transport Investment 1966-1971 76 17 Proposed Power Investment 1966-1971 .... ...... 79 18 Growth of Exports ..............83 1.9 Export Forecast for Marine Products 88 20 Framework for the Balance of Payments: Current Accouit ......9............................... 90 21 Gross Foreign Capital Requirements antd Debt Service ........... .......................... 93 LIST OF CHARTS Chart No. I Korea: Financing of Investment, 1955-1965 II Korea: Relation Between GNP (1960 Prices) Commodity Imports (U.S. Dollars) and Current Account Deficit (U.S. Dollars), 1955-1965 III Korea: Public Revenues and Expenditures, 1958-1965 IV Korea: Required Level of Capital Inflow in Relation to Domestic Savings and Investment V Korea: Ratio of Debt Service to Exports of Goods and Services VI Korea: Ratio of Debt Service to Savings LIST OF VOLU1,ES Vo lmme No. I The .lain Report II TheT Demopraphic Scene ITT Agriculture IV Fisheries vw Manulfactuir ngC VI'f T P"-i4ncs e Ioy and Credit V .1.! - L1c I ir a.Xc e VI.II Statistical AppendJx flA Cr'Tr mA A .DħiKOJ . JJbU.iA Area: 38,426 sq. miles Popu]ation (1965): 29.1 million Rat,e of growth (1960-65): 2.84% per year Population density (per sq. mile): 759 Populaition density, per sq. mile of arable land 3,591 Political status: Republic Gross national product (1965): Won 779 billion Rate of growtl-L (average 1955/57 to average 1963/65): 5.3% (1S'65): 8.0% Per capita (15965): US$99 Gross domestic prodluct at factor cost (1965): Won 772 billion of which, in percent, Agriculture: 36.9% Fisheries: 1. 1/ Manufacturing: 19.6o Transport: L.0% Percent of GNP at market prices 196q 196o-65 Gross investment 11.7 13.1 Gross savings 3.2 3.2 Balance of pavments current account deficit 8.5 9.9 n~~~ ..1 ) -I e! Government currenT revenues 1-.3 2.,, Resource gap as % of investment 72% 75% Money and credit Annual P.-ate of chAn-----e lotal mioney s-uaj J1 Time and savinLgs deposits 94% 33% Bark credit to private sector 31% 18 Rate of change in prices 10% 26% 2 - Public sector operations (in bi)lion won) 1965 (consolidated budget) Goverrnment current receipts 88 Government current expenditures 77 Surplus/deficit 11 Government capital expenditures 34 Budget support by U.S. 28 External public debt including government- guaranteed private debt (in US$ million) Debt outstanding as of Dec. 1963 Nov. 1965 Total debt outstanding 187 391 Peak debt service 20 (in 1967) 3L (in 1973) Peak service on this debt as percent of expected foreign exchange earnings 5.9;% (in 1967) 7.L% (in 1970) Balance of pavments (in US$ miilionn) Annual rate of increase during 1965 i96O-65 Total exports t'.o.b. 175 )0 T'otal imports f.o.b. 420 7% Net inm sihles ),7 35,% of which inveEtment income 1 Net. rm-rrPnt. account deficit 19Q -5I Gross foreign exchange reserves 160 Th6 (or 5 months' (or 4 months' I,4..ħS~~~~~~~~~~~~~~~~~~~~~~; Sv Jl Stor^-+c Jk43 *\LL..JU TMF poslion (in US*T llZ o .Lvve. L.)U/ "JL4 w-v LU.U ħ U.V Drawings - External firnancial assistance (in US$ million) Ave. 19601/6 1965 Total disbursements (excl. short-term loans) 259 238 of which U.S. grant aid 201 133 Private donations 37 69 Excluding budget support by United States. [ (4'; Jeoar t | 6 K O R E A Xst O . > > | 9 z L _ . ~~~~~~~~~~~~Sokcho | .-; wonmunjonn { / * *u/jtD I <<>f {X A / w~~~HUNCHON/ | /t _g~~~~~~,,7Uijongbu , /Kangriung I 'S7Ca ; *- * - -* - * %*K A N G W 0 N O | InchonC;n;\Q(2< ~~~~~~~< * ^) ~~M,khoA a $ v; )j oni~~~~~~~onu D - t'./! *- .......... 5 t *. Kintho99 ˘ t pohongZ,Kirlt | rq~~~~~unsu-f ,. Poa gn \n | ) XC~~~~~~~~HONJU t> . f % J -CI ; ° ; * *~~~~~A ( TA E0 ng C,~~~~~~~~~~~~~~~~~~~~~~~~~~~~~ It < | s _OYosu ChungmuWNGJU 5 tj Vlondo MA I t ROADS~~~~~~aso rHJU 0 Su nc h 0Samchenp Mop CHEJu; C, 0 0 4 0 a o Chungmu ~ ~ ~ ~ ~ ~ ~ B vI?2 S2UV.I'LARY A; DONICLUTSIONS From 'Economic Report "The Economy of Korea" A. Production and Investment i. A marked acceleration in the growth of real -inco-e took place during the 1960's under the stimulus of the First Five Year Plan (1962-66). Koreals growth rate of 6.3 percent per year was considerably above that cf most developing countries. The speed up in production was partly the result, of a rise in the rate of fixed capital formation to 13.6 perce,nt of GNP during the First Plan. Available data, admittedly imperfect, also indicate a substantial improvement in the overall productivity of investrient. 2. Korea is one of the few developing countries where food production rose faster than population growth. Total agricultural output rose 4.3 percent per year. Accidental and transitory inliuences play a small role in explaining recent, trends. By and large, the acceleration of agricultLural production was related to a set of policies which expanded the cultivated. area, raised the extent of double cropping and provided incentives as well as prerequisites for increasing yields. Opportunities for agricultural expansion in the near future are impressive, although non-repetitive to some extent. The Mission postulates annual output -iroTLh of 5.0 percent during the Second Plan (1967-71). Korea may find it difficult to sustain such a pace of expansion during the 1970's, owing to the exhaustion of virgin land. The Mission endorses self-sufficiency in foodgrains as one of the objectives of agricultural policy; it should be possible to reduce sub- stanti.ally foodgrain imports by 1971. How,ever, the Government should place more emphasis on diversifying the cropping pattern, presently dominated b:y cereal production. The aim of policy should be not only to stimulate pro- duction but also to increase efficiency and reduce subsidies. The Mission reconriends sizeable investments for land reclamation, irrigation and land cons o]Lidation. 3. The fisheries sector provides a livelihood for more than a million people at very low levels of productivity. The main reasons are the dearth of capital equipment and the technological as well as organizational backwardness of this sector. However, the natural resource position is relatiLvely permissive and the outlook for demand, both domestic as well as foreignn, is good. Korea should be able to capitalize on the opportunity to build a (ieep-sea fleet and establish a foothold in the international tuna r.arket, provided timely action is taken to alleviate the training bottleneck. 4. Manufacturing was a leading sector of the Korean economy; value added expanded much more rapidlv (9.b. percent per vear) than in most deMelopin! countries. The growth of Korean manufacturint was stimulated by t-e process of mnport substitution. I'urt-hprmore,; a phenomenal growth of exports in recent years provided additional impetus. Manufacturers earned handsome prof,its part4ly owing to the 1ow exccbhange rate, or negative interest rates charged by organized banking and a variety of tax exemptlions and quantitative restrictions on competing imports. The protective - ii - umbrella over Korean manufacturing was rmiore or less impenetrable and domes-bic prices for major industrial products were considerably above those in Japan or USA. Despite a high cost-price structure and excess capacity in some branches, the Mission is impressed by the recent growth and diversification of output and the prospects of further industriali- zation. Given the sparse endowment with known natural resources, manufacturing will have to play a leading role in the country-s develop- ment. No other long-term growth strategy is conceivable. 5. Industrial wages are relatively low and they are likely to remain low, in view of existing underemployment and the expected growth in the labor force. Korean workers are not only inexpensive to hire but literate, hard-working and disciplined. Furthermore, there is no dearth of entre- preneurial talent, although few industrialists can boast of long experience. Owing to the scarcity of mineral and agricultural resources, Korean manufac- turing depends heavily on imported materials and this characteristic is likely to persist. An ample supply of low-wage labor is the country's chief asset and the main basis of her comparative advantage in international trade. The Mission visualizes a growth in manufacturing production of 1CY0 per annum during the Second Plan. Detailed work at the project and industry level will be necessary to tiest the operational feasibility of this produaction target and to determnine whether or not such a pace of development will strain Korea's managerial or technical resources. The obvious lines of import substitution are nearing completion. Certain of the heavy industrial projects now under consideration require very careful assessment of costs and benefits. Failure to apply the right criteria for project selection and to supply the right incentives to industrialists may have far-reaching conseauences for the competitiveness of Korea's manufacturing industry. 6. The Republic of Korea started its indeDendent career with a tremendous gap in its infrastructure. As a result power consumption was rationed for the best Dart of the last decade. During the First Plan installed generating capacity was more than doubled and restrictions on power-use were removed in April 1964 miring the Second Plan, demand for power is expected to rise at 12% per annum. A recent survey, sponsored by the IU _S Government; pronosed an investment program. consisting mainl;y of termal plants, to expand capacity in line with demand. The Mission recommends a change in the price relation between coal and oil designed to promote the use of oil in thermal plants. Such an adjustment is necessarj from the stanriPoint of the country's overall energy balance. 7. The First Plan. emphasized the modernization and -v0lopment of the railroad to meet transport requirements. A survey team sponsored by the WITorld Bank has recomm.ended an, overall program for the transport sector which rightly stresses the role of highways; the acceptance of these proposals would constitute a major departure from, past policies. The tentative framework for the Second Plan, fo,'-ated by the Economic Planning Board (EPB), envisages a growth in total real income of 7%0 per year. Fromu the starndpoint of production possibilities, such ar, increase seems quite feasible provided there is no financial constraint. Korea has the administrative capacity and the know-how (suitably supplemiented by foreign tiechnical a-ssis+.ce tii h a prograT a Tn i ng political stability and a favorable climate of economic policies. However, we had-ve ser-ilous reservatiors about I cp t . finqnnce qi1('h 2 growth rate. B. S.avings aLud Forei,gn Capital 9. The financial feasibility of the tentative target of raising income by 7 percent per year depends on the valiħui y of several WIQua Uħs, r.adeby the EPB regarding investment requirements, the behavior of domestic savings and the net inflowr of foreign capital. The planned val-ues of forei,n capital inflow are high but even if achieved the iEIission is sceptical joult the chances of reaching the very aibitious savings target proposed by the plarners. The.asuamption is that 35 percent of the expected pincretment in income will be saved. unfortunately., it is not easy to compare this target with the historical record, owing to serious statistical problems. Available data in current prices indicates a savings rate of 2.3 percent. in 1960-62 and 5.8 percent during 1963-65. The low level of savings reflects the economy's structural characteristics - poverty, relatively equal distribution of income and wealth, a large subsistence sector, backward financial institutions and an undeveloped tax system. 10. Public savings were negative till recently. The size of these- budgetary deficits., relative to GNP, diminished and a positive balance was achieved for the fiLrst time in 1964. This was a notable achievement; it illustrated the Govrernment's determination to follow disciplined financi-al policies. However., the budget was balanced not by raising public revenues but by a very sharlp reduction in current expenditures, relative to GNP. The austerity in public spending had certain undesirable side effects - a 50 percent decline in the real value of public salaries, a deterioration in standards of elementary education and erratic fluctuations in agricu:Ltural subsidies. 11. Private savings did not describe any clear trend. There is evidence that inflationary developments undernined household savings and impaired the efficiency of organized banking as an instrument of resource mobilization. Recently progress has been made in controlling inflationn After increasing by 21 Percent in 1963 and 35 percent in 1964h, prices rose by only 10 percent in 1965. However, confidence in price stability is not yet firrlmv established. Relaxation of ceilings on deposit and interest rates has improved the competitiveness of organized banking. The Government should continnue to follow disciplined monetary Dolicies to convince key elements in the financial world that price stability will be maintained. 12. Considering this history, Korea would be 9howing satisfactory progress in the field of resoce mobilization if she achieved a marginal savin-s rate of 20 percent durin-;: the Second Plan. This increase in savings has to take place in both the public -ad the prvate sector -nd Goverrnmer-t policy should be designed to foster increasedt savinj-s in botll. Howeveri t.here is no doubt that a major effort trill have to be made in the public sector. Korea's present tax effort is comparatively small. Sharp increments - iv - i lrevnue c-a,, 1-n VI i I i nrltTn be c-lie, +by - h co,p e,,nd rat-e- on ,i f irndre t taxes as ijell as by irprovements in tax administration. Provided the Missio-n's rec.edtin r zlmned h al rpbi av; to GNP' wtill increase to 5.5 percent by 1971 while total savings a- L. L '1 J approaches 1 0 percen. the suggested tax reform, and if external aid were forthcoming on a scale to ma;ch udorestiLc S-1vngS, iLt sIt.Jhoud. ther. be VW - - - - - - at a 'Level which would maintain the growth in income at an annual rate of about 6 percent. Th,e r'equired net inflow of foreign aid, on these assup- tions., would average $275 million per annum compared to $264 million during i96i-L965. Considering, howe-ver, all the - prospective foreign aid flows and domestic savings patterns, it is important that the Second Plan be devised in a way which would permit Can orderly reduction , i investment in the event of shortfalls in either domestic saving or external aid. This means that there snould be a fairly clear idea of the relative. priorJities among investments included in the plan as well as an understanding of adjustments that would be necessary in the components oi tjeP raLWif the over-all size of the Plan had to be reduced. 14. Korea has been one of the major recipients of foreign aid on concessiona:L terms. She obtained three times as much soft aid, on a per capita basis, as the overall average for all developing countries. The future outlook for foreign aid to Korea is not at all clear, except for the Japanese cornmitment recently spelled out in the normalization treaty. Responsible U.S. spokesmen have indicated that supporting assistance will be phased out. Recent events foreshadow a shift from grants to soft loans and suppliers' credits. Considering the long time it will take to eliminiate the resource gap between investment requirements and domestic savings, the ideal solution woulcd be to extend soft aid to Korea. However, a global shortage of soft aicl may well rule out this solution. In this event, soft aid may be supplemented with conventional loans, provided Korea demonstrates her capacity and willingness to raise sharply the economy-wide marginal rate of savings. Korea's existing debt is not very large and with an ade- quately risingz trend of saving the country would be able to service a significant increase in conventional debt. C. The Balance of-Payments 15. Korea's balance of payments deficit has declined noticeably compared to the mid-fifties. This is the result of considerable import substi.tution and, more recently, of a startling rise in export earnings (3?7 ercent ner year). Partly this increase in exports reflects an extra- ordinarily low base. Also non-recurring events created a temporary demand for somR Korean products. However, much the greater part of credit for buoyancy of the export sector should be given to an important switch in GoTvernrient. ;attitudes from exclusive emphasis on import substitution to a more balanced trade policy. This reorientation was reflected in successive devaluations as well as in a ninber of complementary measures designed to compensate exporters for the persisting gap between official and "realistic" exch-nge rat;es. The most conspicuous promotional measure was a system of preferential credit arranements which generated powerful incentives for producers to mter the- Uo-- maret He ,L t L)J s does not distinguish between products in which Korea can hope to acquire a -omc.nA--+-r. -d'vr , A-,d other commod,t44-Jes 16. LTh ' " CA.4 a t5A - LI al U Q C2 at L11tIU.L tL a, Mte o f 2) 1 percent per year during the Second Plan. This is a very ambitious target - 'Adhe conAfl-C of tULie 1kely eX-jjWiiU11 Lii wlJ-ULU Urade. T lie i"iħLOOnl sug,gests a scaling down of the export target to a growth rate closer to about 15 perc-un per year. 17.* The mac:o-framework envisaged by the Mission allows orea s Jinports to increase by 7.6 percent per annum during the Second Plan. Alt1ou- we cannot rigorously test the consistency oI assumptions under- lying the analysis of production and investment on the one hand and imports on the othier, we feel reasonably certain that such a growth rate of imports will suffice. The historical behavior of imports is enigmatic and a precise anaLysis is ruled out by serious data deficiencies. During the past decade, Lmports lagged behind production. However, during the sixties inports increased faster than GNP. These ambiguities notwithstJand- ing, it is clear that Korea has secured substantial import substitution, al-Liough the cost-price structure is high. The Governm.ent is aware of this situation. In these circumstances it would probably be advisable to =onsider a phased program of decontrol. Quantitative irport restric- tio:as mright be replaced by protective tariffs in the first instance and1 then followed by a schedule for lowering tariffs, allowing time for rationalizing management and reducing production costs. During the SecDnd Plan savings should be realized in imports of foodgrains, selected capital goods and possibly chemicals. 18. Future developments in the balance of payments Will be greatly influenced by changes in the exchange rate. Broadly speaking, it would seem advisable to continue the present policy which had its beeinning in May 1964 and which culminated in the establishment of the floating exchange rate system. D. Is Korea Another Taiwan? 19. The auestion raised in the title of this section is imiportant from the stan(doint of policy. The growth path chalked out by Taiwan has led to a ranid phasing out of concessional aid to that countrv. Is it possible to foresee a similar termination of the need for concessional aiist.anc-. to Korea? 20= The Missionls view is that the ana1ogy with Taiwan is interesting and useful, provided we also bear in mind several important differences between the two cases. F -st ofall, the . ni- it--- -oth -n-r---es have received substantial foreign assistance and scored impressive growth r,ate _ pro-d i o1 - as we 'afB+h hnavre vr-ynr M"4g proplantion. £ - VU0 ~ jJS 'SU USIJ a ~ O YLIJ.J aL UL. ~ 'X l - j£ - L ,- densities, although Taiwan is probably somewhat better off with respect to natur rIeCLrL ce~s.U LAlkt I UjbotLh u,i ,rU.e L 0 e h .i,l liter and receptive to socioeconomic change. Taiwan has already witnessed a substantial decline ln fertility, wuhile lorea appears to ue on the brink of such a demograLphic transition. .. vi - 21. And now the 8jffPrences ronts per cap4ta incompe is much lower than that of Taiwan., Korea's civil service and business community lack the seasoned matu-rity of their counterparts in Taiwnn. Finally and mst. impnort- ant, while Taiwan has already achieved a high savings rate, Korea is far in the rear A cizea1. _nfo- o-f fovre.v A int+o Korea helprd to+j finnrice a rise in capital formation and to accelerate income growth. Whether there was ceul sucnnces- th ri---- hrea.- -vng s- -- -a ; * problematic. -on under optiistic assumptions regarding resource mobilization policies, but barring aa mir racle, t akeC;, a lon tV11 ime to- ar.v at the sage whe- r she can generate sufficient domestic savings to finance an adequate rate of growUsi.LtoLIVUI OL s Ubt .tia. fLUoLr l l assistance ol ulIueuorulal ter-ms. 7rom Eronowrn Report "The Eonnomvy of Korea" (Report No. FE-55, dated June 2, 1966) THE ECONO0MY OF KOREA I. INTRODUCTION 1. A study- of Koreals econo-rji history and future -s of considerable value in judging the effectiveness of massive foreign aid and technical _ ~~~~~~~~~~~~~~~~'I - _ _ n_ __ __ _/TT:n_|L '3 - - - - - '4 __ assistance in Securing economic development. Wial.e| thi s rptdo notu pretend to be an exhaustive analysis of this kind, some of its conclusions are relevarnt in this context. The aim of this paper is to present a bird's eye view of past de!velopments and future prospects of the Korean econony. An attempt is made to identify the major growth impulses and to evaluate economic policies of the Korean Government. 2. Recently, many observers have drawn attention to the success story of Taiwan; an economy which has derived considerable growth impetus froml foreign aid leading, recently, to a termination of U.S. grant assistance. Responsible spokesmen of the U.S. Government have indicated that Korea is likely to follow a similar path and that grant assistance will be phasedl out in the foreseeable future. Is Korea another Taiwan?, therefore, sounds like a question wh:Lch is not only academically interesting but also per.- tinent from the standpoint of practical policy. An important concern of this report is to point out similarities as well as differences between Korea and Taiwan, which are relevant in answering this queEtion. 3. For the zonvenience of the reader, a few words about the sequence of this report may be useful. The document consists of a Main Report, which summarizes the highlights of the Mission's findings, and seven additional volumes which present the detailed analysis and statistics. The general reader may prefer to overlook Volumes II through VIII, which may be of some interest to the snecialist. The first four chapters of the Main Report are concerned with various aspects of past economic growth; trends in production, canital formation. savincs, the role of foreign aid and developments in the balance of payments. The last three chapters deal with the future outlook for the Korean economv. The provisional framework for the Second Five Year Plarn (1967-1971) is discussed and the Mission's observations regarding the feasibilit-v of tentative tarpets of total savinLgs and investment are pre- sented. This is followed by an evaluation of production possibilities and inuos+.TfnP1-+ rPmiirreii .e in tr'mmn +.v-_nrnlT(Cinr sectors as well- as transport and power. A rough assessment of prospects for major exports is made; a firm forecast w0ould require .much rmore intricate, time-consming analysis. T'he Mission is unable to project import requirements at all precisely. Detailed work~'~r at- t- J c and.. 4 O"q 1A71C+7tr 1 woldA be K fiv- scnh a-n exer- cise. Finaally, we discuss the net and gross foreign capital inflow re(quired to suta- - 4-1,. --mer.t-. of 4-the - - -.- .n----n m- -a e.l - s1 t.h rla +ic se of the terms on which foreign resources should be made available. The cal- c .Lation of fore.1ip ,n capitlUC requirem,ents rests41 .air' on-n our assesS.ment; of the savings-investment gap; the analysis of the balance of payments provides a rough consistency check only. - 2 - 4. Before tackinng this agen-da, we will spell out. some of the salient features of the Korean economy so that the reader can identify the conlntry on th.e vnariegated mAp of the developin.g wsorld R.eaders familiar with such background information are urged to turn to Chapter Il. 5. The Republic of Korea is among the poorest countries in the less developed wol r statisticv indicate 4-hat Korea's er- capita income in 1965 was the equivalent of U.S. dol'lars 88, i.e., approximately 4-, E n..,-1 a(r r4, n l,;^ rflA;,., .,.-c , C' ,ra.. ,,nn A A n A _ . I ,r ^ 1 e nnra.+xar tvf L A t% e CIUc W; v4; e IL ai[l vilach 'L,,Tan -VCa ]_1f Q- - 6U -P G V - -Vi - -- -- is not much less than that of India, Pakistan, Nigeria, Sudan and East Afric.a. However, ternational cor,.parisons of per capita income are hazarclous: visual impressions do not corroborate entirely the statistical fiIndiring of extremL[e po-verty. Perhaps this is auue to tiie Lauc Utha U in Korean income and wealth are not as glaring as in other developing colm- tries.L In terms o sheer n-u'ers, the problem of Koreafs poverty is not colossal as in South Asia. With a population of 29 million in 1965, Korea belongs to a group of about a dozen medium-sized countries such as Philip- pines, Thailand, UAR, and Turkey. 6. In general, Korea's demographic characteristics are shared by many developing countries; high fertility, rising life expectancy, rapid growxth in numbers and a very young population (See Volume II). The rate of population growftih in Korea (about 2.8 percent per annum) is considerably lower than in Taiwani (3.5 percent per annum), largely because the death rate in the latter country has already fallen to a very low level. Both countries suffer considerable unemployment and underemployment. Korea is more urbanized than one would expect on the basis of the economy's pro- ductive structure and the stage of development. Seoul, the capital city, has a population of 3.4 million. The rate of urban unemployment is much higher than the country-wide average and there is a severe housing shortage. 7. The pressure of population growth in Korea is the more keenly felt because the country has a sparse endowment of natural resources. The cli- mate and topography are such that only one-fifth of the total land area -s under cultivation. The farmed area, per capita, is 0.08 hectares 1/; among the lo-west figures in the world. The soil conditions are not favorable. The organic matter of the soil is depleted owing to heavy rainfall concen- tratedi irn a few months and deforestation caused by war as well as excessfive cuttinigs. Mineral deposits are thin and generally low, grade. Korea has considerable hydro-potential but the cost of generation is likely to be high owing to certain physical impediments. There is only one exception to this story: marine resources in the seas surrounlding the Korean penin-- sula are large enough to sustain a significant expansion of the fishery industrv. All considered. the Mission susnects that Korea's known natural resources compare unfavorably with such assets in other developing countries. Although Taiwan has a higher npoulation densityv her rpsmurce endowUm1ent is not as bleak as Korea's. 1/ The corresponding figure in Taiwan is even less 0.075 hectares. Siee Volume Ill. - 3- 8. Although nature has not been kind to South Korea, the country's human resources are impressive. A massive campaign waged after independence redripe illitprpar from 78 percent of the adult nopulation to 11 percent in 1962 accorF!ing to official data. The country is also well endowed with uni- versity anvd high school graduates; in far-t_ there is an excess of supplv over demand for graduates of a liberal arts orientation. The pay-off of the anvestment in human capital is vi s-ble in mnmnyr fmrm.q t.hp npnnulnr aqraTreneSs of economic policies and plan targets through newspapers and other communi- cat-ior, n,edi.a, h wqin..s go lesn, rd h nczssidhimiu colletor--n annd processing of statistics on every conceivable subject. 9. T'he Mission is also impressed by certain intangible factors in the AKoreanl si tIt- U vorLU-Li. lites 1WackOrs, a_lbUgh diffic '..._t.," to 4q&U1ViLY.9 are of con- siderable importance to the climate of economic development. The social up- heaval, caused by the Koreanl War and b)y Uhe political events after the Syngman Rhee regime, seem to have reduced the weight of elements of rigidity in the Korean psyche and SCoiet1Y. 1/ WilL1ngneSS tO acceti socio-economic chanLU ge is evident ir, many aspects of life. The Government is not pre-occupied with political problems, unrelated to the development drive. PoliLical issues, (language, regional loyalties, disparity in wealth or status) which absorb so much time and create so much tension in many developing countries, dci noti attract much attention. Korea seems to have a genuine sense of national identity. 10. Of course, political problems do exist and representative govern- ment is not firmly established. Korean students, in particular, have shown considerable restiveness on issues such as relations with Japan, civil 1i- berties, re-unification with North Korea. etc., in recent years. The desire to leave the country and establish residence abroad on a virtually permanent basis is widespread among the intellectual elite. Frequent changes of cabinet ministers and re-assignment of top-ranking officials are part of the Korean landscape, although there is some evidence that the incidence of such 1/ A few facts regarding the modern history of the Republic of Korea may be cited. After 35 years of Japanese rule, the country was divided into hostile political blocs at the end of VWorld War II. This was followed by the Korean War which caused widespread destruction and a large inflow of refugees into South Korea. Syngman Rhee, the first President of the Republic of South Korea, held office till April, 1960, when he was compelled to resign and go into exile. This was followed by at government headed by Jobn M. Chang which was overthrown in iIay:, L961. bv a military coun d'etat. The militarv iunta ruled the country till in 1963 elections were held and General Park Chung Hee, who wa, the Chairman of the mnilitary iunta, arnd hi-s Dpmocratic RLepublican Party won office by narrow margins. The Republic of Korea's external re- SLat. w AeNdoir.+ate I+ r t+ho enrfron .tticon with North norea anti mainland China;, the internal debate about normalization of relation3 with Japan and the military as well as econom.ic invw.olvTement of the 1United States in the country's affairs. disturbances has d:uminished lately. After dragging on for more *than. a Udecae, neWotdatinS.I -.wi tlth: IJ tot ere-tesUL L.tabls. , e Uof ħUlIId,U- cLLIU commercial relations were concluded successfully in December, 1965. The Republic: o.f Korea iLs deeply involved in fighting the Viet-ħIm war. The Mission is not competent to judge the prospects for political stability Utu competent observers are reasonably optimistic. TLhne next elections are scheduled for :L967; the first year of the Second Plan. U. On the premise that political stability is assured for the foreseeable future, the Mission:s judgnent is that social and cultural factors in Korea are more favorable to development than in most developing countries. On the whole the situation is comparable with Taiwan, althoghn Koream civil servants and business leaders lack the tradition and exper-Lence of the emigres from mainland China who manage economic affairs in the former country. 5- II. IT>T1'QM1Sr?1 CTTJT OTP ANTT) ZTi.qvT11T (1955-1965) A. Macro-economic Picture i2. A marked acceleration in ,he gro-,wth of real income took place during the 1960's, under the stimulus of the First Five Year Plan. Nearly all sectors of the economy participated in this expansion but gairns in the speed of manufacturing were particularly impressive. The growth process involved structural changes in the composition of demand, output and emiSploy- ment. There was a perceptible increase in the ra-te ol fixed investment accompanied by a rise in productivity. Employment opportunities increased in many sectors but particularly in non-agricultural activities. The total numaber of jobs probably increased faster than growth in the labor force. 13. These generalizations regarding the Korean growth process can be supported by relevant statistical series. There is no dearth of data in official publications; if anything, Korea is relatively well-endowed from a statistical standpoint. Nevertheless, the Mission encountered consider- able difficulties in judging the reliability of these numbers. For example, it was recently discovered that official statistics seriously underestimated the production of rice and barley (two of the most important crops) as well as manufacturing. Furthermore, many of the basic numbers are difficult to interpret on account of the undervalued exchange rate and price inflation. iNow that the exchange rate and the price 3evel have been "normalized", in official jargon, the economic statistics will be easier to comprehend tlan heretofore. This is one of the incidental by-products of economic reforms which have pervasive repercussions throughout the economy. 14. Available data regarding value added, investment and employment are summarized in Table 1. The IvMission has linked national income accounts for 1960-1L?65, revised in December 1965, with unrevised data for earlier years. 1/ Admittedly, this procedure is technically imperfect but it serves to illustrate long-term growth trends and to place recent events in a somewhat longer time perspective. 15. The rate of growth of total outnut. in constant prices, fluctuates considerably. GNP rose at a record rate of 9.3 percent in 1963 when an import boom permntted manufacturing output to girow by nearly one-fifth and when the harvest was above normal. By contrast, the total volume of output decl;ned slh in 1960 when bad weather denpressd agricultural production and political instability inhibited the manufacturing sector. 1/ The average percent difference between revised estimates and data pub- lished in B.0 .K. Economic Statistics Yeabook, 1965 for 1960-6L was applied to data for 1953-59 in this yearbook. This procedure was used to establish the series for GNP by industrial origin and for v expenditure categories. See Volume VIII. - 6 - T'able 1: PAST TREIDS IN INVESM1T, ]E{PLOYMENT AMID VALUE ADDEI Agriculture and ItemL Fores try ishbig ManCacUEj4,ng Poweril Transort Housin Al Sectors 1. Annual Grcrwth in Value Added /2 (%) T-a Average 19SS7/' to Averae 1963/65 3c7 4h- 9.! 11.5 1.7 2.1 .3 (b) Average 195,9/61 to Average 1963/65 4.3 5.5 12.:L 11.1 12.7 2.4 6.3 2. 4nnual Growth in Value Added pier Work:er LT5 TTAveraget 195;9/61. to Average 1963/65 ------2.0------ 3.0 15.1 9.'8 n.a. 2.3 3. Incremental CapitalLOutput Ratio /3 -- 0 .69-_ 1.35 9.14 14.4 10.0 1. 76 /4 14. Ccompition of' Value Added. Percent, a Average 195 7 prices) 37.0 0.9 12.14 0. 6 3.5 7.3 100.0 (b) Average 1963-65, (1960 prices) 32.8 O.i3 16.8 1.0 5.6 5.7 10).0 (c) 1965 (1965 prices) 36.9 1.1 19. 6 1.;2 14.0 3.6 100(.0 5 . Compos,ition of' Raloent Percent a 1960 -----65.9 ------ 6.18 0.2 2.1 n. a.. 100.0 (b) 1964 59.8 2.2 8.:L 0.2 2.0 n.aa. 100.0 6. Ccp osition of' Fimed Investment Percent a Cunmlative (196, 196 prices) _----11.0------ 21.5 9-3 2,2.3 1L2. 100.0 (b) 1965 (19,60 prices) ------7.9------ 25.3 7. 6 20.9 i1.9 10.0 2a. Velue Added per Worker Aver 1963/65 Average All Sectors = 100 54 39 206 618 2814 n.a. 100.0 /1 Includ,es water supply and sanitation. 7T Compound rate! 196(O nri esp T Fixed investment in 1960 prices 1960-64o (cumulative) divided by increase in value added 1960-65 also in 1960 prices. If' the relation is expressed in terms of total investment including changes in inventories, the coefficient is 1.97. Source: V'olumLe VIII: Statistics -7- 16. LEvening out these fluctuations by the use of three year averages, the long-term growTth rate was 6.3 percent per annum, during the 1960's ccm- pare-ed to 4.l percen4t in theLI le l'. On this Iasis Kooreas groTth r ate during recent years was considerably above that of most developing countries. HoweVeT, Israel, Taiwan andħW ThU. a ħLanuid are among I tIL he fLPew countIriCS who e41 ienced a higher growth rate than Korea. On a per capita basis, Korean GEfP increased 3.5 percent per year. 17. Comparison of' actual achievemnents with targets of Korea's First Plan are difficult on account of statistical problems. However, if suitable adjustments are made, then it appears that actual GiNr in 1965 is about 8 per- cent higlher than the target of the Original Plan and about 11 percent higher than the target of- the Adjusted Plan. Per capita national income in 196', amounted to won 23,630 or the equivalent of $88 at the prevailing exchange rate. 18. The acceleration in the growJth of production was partly the result of a r'ise in the rate of caoital formatiorn. The ratio of fixed investment to GNP according to available data, was less than 11 percent l/ in the mid- fifties and f'luctuated around that level till the inauguration of the First Plan. There was a steep increase in 1962 and 1963, followed boy a partial retrenchment in the next two years in the interest of financial stabili-- zation and economic consolidation. The average rate of fixed investment during the First Plan period was 13.6 percent. 1/ 19. The rise in the rate of capital formation -took place in a climate of' strong inflationary pressures. The annual rise in prices was nearlyr twice as fast in the 1960's than in the second half of the 1950's. 2/ The inflationary process brought about notable changes in the price structure which must have inf-Luenced both the tempo and the pattern of capital forria- tion. For example, prices of investment goods lagged behind the overall price level during the 1960's reflecting the subsidy via the exchange rate system. In such an environment, inivestors wjho managed to secure import licenses and cheap credit through the Government controlled banking system reape(d tremendous windfall profits. Fortunes were made not only by manu-- facturer's and other producers but also by speculators who manipulated in- ventories of artificially cheap imported goods. 20. Nevertheless, a substantial improvement seems to have occurred in the overall prnAuctLvit of investment, The incremental capital-output ratio (the relation between increase in fixed capital and rise in value added! declined from 2.71 in t-h later 1950's to only 1.76 in the 1960's. The present Korean ratio appears in a rather favorable light when compared with other countries at similar stages of' development. Indeed, there is ' _ / resseA r 190 pics 2/ Th]e wholesale price index increased by 63 percent dr1ing 1955-60 -nd by 121 percent diuring 1960-65. -8- scarcely a cdeveloping country which has recorded a lower ratio in the recent past., 1/ The Mission finds it difficult to interpret the signi- ficance of this ranther loT capital coefficient in Korea. Partly, this ia the result of a downiward bias in the statistical estimation of invest- ment. The 'iqission has reason to believe that national income accounts underestimate investment in the form of construction, particularly in the agricu-tra:L sector. (e olume IIT) Otther observers have drawn attent,ion to omissions of construction in public utilities, railroads, mining and urbaL housing. 2/ Futthermore, thle too low exchan-e rate implied that imported machinery and equipment (about 40-50 percent of total) was under- estiniabed in terms of' won. wvorean investors were receiving a substantl subsidy from the rest of the economy. 21. A sizeable proportion of capital formation is controlled by the public Sector. Direct investmnent by the Central and Local Gover.nments as well as CGovernment enterprises account -*or about 30 percent of total invest- ment in the economy., 21 The role of' the public sector i;s consideraby higher in powier, triansport and agriculture than in other sectors. In addit:ion, the Government influences private inves-tment decisions through its role as a financial intermediary. Loans and grants for investment pur- poses are nearly one-fourth of total public capital expenditures and about 15 percent of private sector investment during the First Plan. These capital t;ansfers from the public sector are administered th'rough Govern-- ment departments and specialized institutions such as the Korean Recon- struction Bank (KRB) and the National Agricultural Cooperai-ves Federation (NACF). 22. Acceleration in the pace of capital formation generated job oppor- tunities and an increase in labor productivity. (See Table 1) hnPloy_nment increased at an annual rate of 4 percent per annulm diuring 1960-6 7 compared to a growth of 2.6 percent per annum in the working age population (15-59 years). In all probability, the pressure of unemploynent and underemployment wJas alleviated somewshat during recent years. However, the present position is far from reassuring. According to the quarterly survey of the economi- cally active population, the rate of unemployment averaged nearly 8 percent dturing 1963 and 196,4. Furthermore, nearly a quarter of those classified as "enployed" by this survey were looking for additional work. According to ano-ther source, chronic and seasonal underemployment affected half the la'oor force. 1W 1/ Taiwan, Philippines and Thailand are reported to have capital coeffi- cients (fixed and inventory investment related to rise in value added) centering around 2.50 compared to 1.97 in Korea. 2/ L. Grose: "Evalua-bion of Korean National Income Accounts"1, Consultant, Nathan Advisory Group, November, 1965. 3/ See Volume VII. 4/ Siee Volume II. -9- 23.I The Mission could not evaluate ss+^matriclyr +the effi reny of- resource allocation in Korea. The framework of Government policies during the sixties were not conducive to opti!.m res-lts. First, infla- tion and the undervalued exchange rate introduced distortions. Secondly, Government controlled banks were charging interest rates whIch proved to be negative, after allowing for price inflation. Not only were interest rates too low but they varied according to set of criteria - source of financing, notion of priority of activities - which was difficult to raticnalize. Nevertheless, despite these shortcomiri1-gs, t-le overall results in terms of growth of GNP, employment and the observed capital- output ratio are quLite impressive.. Furthermore, recent economic reforms - the attempt to stabilize prices, the establishment of a floating exchange rate and the upwarcd adjustment of interest rates by the organized banking systEm - should bring about a far reaching realignment of costs, prices and profits in the economy. - 10 - B. zThrnymni' of' Aari cml fn-re 1/ 2h. Although. agriculture has lagged somewhat behind the rest of the econmrir, i.t. rerins +t-he 1 s sector fWrom +thew s+t. nrinto. of va addried and employment. (See Table 1) Korean agriculture, in large part, belongs to~+lnc-n' the sizeable subs n+enacsecar,A v I of thea annnorfx 1aa rly threeqatr of EL11 farms are less than 1 hectare. This is explained in terms of the scar C4ijy C-P c1 -Ival lad4eprsu f ouai.naua-eair ~ t.~L~ ~.Jk. UJ-ħdL Le J~.1 u ULm~F 'Ji. P jUjU1.L%V.L-J. aXL~ Lk a . successful land reform after World War II. Grains, mainly rice and barley, occupy a p'iace of coi, d.-ng -mportance in the fM cr y they account for 64 percent of total agricultural income. Value added per wuork-U iln agricultuUe is Just about half of the national average- 25. Given these structural characteristics one would nolt expect Korean agriculture to display many dynamic properties. And yet, enig- matiLcally enougn, the recent growth record iS certainly impressive. (See Tables 1 and 2) Korea is one of the few developing countries where food production rose faster than population growth. The growth of total agricult-ural production in Korea of 4.3 percent per annum compared favorably with Taiwan (3.8% per annum), the Far East (2. 7o per annum), Latin America (2.9% per annum) or Africa (2.5% per annum). 2/ Table 2: THE DIIENSIONS OF GROIWTH IN AGRICULTURAL OUTPUT, YIELDS A4D AREA Average Annual Percent Change Distribution of 1955-57 Average to 1962-64 Average Total Cropped Crop Area 1962-1964 Output Cropped Area Yield T'9 of tota-l Rice 36.3 3.4 3/ 1.0 3/ 2.4 3/ Bariley 27.3 4.9 / 1.9 E/ 2.9 E/ PuLses 10.4 1.0 1.0 0.0 Potatoes 4.5 9.4 6.8 2.6 Fru-its 0.3 7.5 3.2 4.3 Vegetables t.1 2.3 2. - 0.1 Tobacco 0.8 12.5 2.5 10.0 Cereals 75.4 3.7 1.2 2.5 Source: EPB, Korea Statistical Year book, 1965 1/ Based on detailed analysis in Volume III. 2/ See FAO Production Yearbook Vol. 18, 1964. 3/ Average 1955-1957 to Average 1963-1964. 4/ Average 1955-1956 to Average 1962-1964. - 11 - 26_ The Mission is convinced that accidental and transitory influences play a small role in explaining recent trends. By and large, the acreler2torn cf nrodn 1cion ciuring the 1960's was related to a set of policy variables wrhich speeded up the increments to area under cultivation, which rnased the ex+ent of double cropping and w.hJich provided the incentive as w-rell as the prerequisites for raising yields per hectare. 27. The area under cultivation scarcely changed during 1955-61 but sn,: the- it-,- - ;- l,-R, 4 - - - ati aA iql rae ofn 9 p narrnrn+. The rpt-cm+n , aa uxħl .. *L i ,s aLJ .a.t 144- - - - .-, - - - _ - - - impetus is largely the result of the Government sponsored "upland recla- hid. L,Al F1L %JrJ. d.ULL. J.UJ.Lt d;.LIUIC~ . LV kLUU d.1i I-V.L Li *- S. i.Ci developed for cultivation mainly through bench-terracing techniques. UI L.LS E . UU 1 ħIU~I I i .VU 1J k.IdIIL4CI U-L4UjJI ). .L4 CUL V1l Id.DL: It ,t _L V -L.L dU%AIJjJVL.J L' 1 LJIL %,IL~ U.S. fore:ign assistance program in the form of PL 480 flour,used as wages ..LU iLħLJCIWiLl i 0111 A1( UIiħI.,U 1MaELiU11V L ..UULU.1 £VUIiU, V1CuILLL_L _LL -le .lLJr.h o` ELn Icind aildu fros-latI Unj`e 11-ai-n- opca .,,4ar n 4ULI J.. o technical assistance. 28. The extent of double cropping (area double cropped as a percent Of t'otal cultivated area) nad diminished from a high of 52 percent in 1957 and 1958 to 48 percent in the following two years. Since then there was a steady increase upto 55 percent in 1964. The recovery and sprea(i of double cropping was stimulated by the recently started land consoli- dation (commonly called "paddy rearrangement') program as well as by the increase of irrigation facilities. The area benefiting from large irri- gation projects was substantially bigger during the First Plan than during previous years. Presently, about 57 percent of rice lands are fully irrigated. 29. The average yield of irrigated paddy in Korea is about 40-50 percent higher than rain-fed paddy. Also fluctuations in yields under rain-fed conditions are almost double those experienced in irrigated areas. The increase in irrigation facilities, therefore, was one of the factors underlying the substantial rise in yields secured by Korean farmers. (See Table 2) Also, rapid increments in the utilization of fertilizer and pesticides were recorded. The consumption of chemical fertilizers decl.ned from 1957 to 1959 but since then there has been a regular increase; the 1964 level was more than double the previous peak. Simrilarly, the consumption of pesticides which had varied between 4-6 thcousand tons during 1955-61 suddenly jumped up and reached a level of 23 thousand tons in 196L. 30. The break-through in the use of fertilizer, pesticides as well as other inputs wzas achieved through a reorganization of credit and marketinfr facilities as well as a strengthening of extension services. The NACF, with a membership of 92 percent of all farm households, beceme the sole distributor of fertilizer in 1962. The sale of fertilizer iE; nolt openly subsidlized although low interest rates on NACF fertilizer loans constitute a hidden suhsidvy The feri-AizA7er loans could be renaid in cash or. partly in kind (i.e. a predeterTined quantity of rice). The sale of various other inrputs, .iportant for agrictuiI 1-raIl prcduntivity- were subsidized. Limestone received a subsidy of 50 percent and pesticides of aJut- CO0 perent - 12 - 31. M J'Lore pJ.3ortJ nt+ than -ubsid i on'S '- - e w a s - the -fa that the Korean Government adopted various measures to reduce seasonal ILuctuattions of rlce priL c Ihs atm+ have become quite '-. During the mid-fifties pre-harvest prices used to reach a peak 30 percent - ---- - -_ _ -l -…. -3_ -- -----.---. - nr -,m C.n auo-vH iAe aiuħuaħ a-verage; ini recer, years i, the . j'res .S-~ ng 'i-e a only 12 percent. Similarly, post-harvest prices used to touch a low of 21 percent below the arinual averUae; ħin renLIi Ib th correspondlng figure wras 14 percent. 32. Not only was there a measure of price stabilization but there was a distinct improvement in the terms of trade of the farimier vis-a-vis the rest of the economy. WJhereas grain prices had lagged behind non- grain prices during the late 1950's, this relationship was reversed during the 1960's. I/ More sophisticated calculations by the Bank of Korea confirm that the farmer's terms of trade have improved significantly during the 1960's. 2/ Since 1961 the Government has been supporting the prices of rice and barley and since 1963 the support price is fixed on the basis of prices paid by farmers for agricultural inputs as well as for household consumption. 33. Altogether, policies of the Republic of Korea have proved fairly effective in igniting a spark of dynamism in the agricultural sector. This is not to say that weaknesses do not exist or that improvements are not feasible. The following instances come to mind: (1) Knowledgeable observers have drawn attention to signs of- some deterioration in the situation regarding tenancy and absentee land ownership; recent surveys show that 14 percent of the cultivated area is farmed by non-owners. (2) Despite recent improvements, the NACF only supplies 27 percent of total farm credit at present; the remainder comes from private lenders on exorbitant terms. (3) The IMinistry of Agriculture and Forestry is handicapped by a shortage of technicians and project analysts. Some of the irrigation projects have proved to be extremely e3pens v e (I) nern.t'rycntrnin1t-. have nreventedri the GlovernmPnt frorm fo:Llowing a consistent policy regarding provision of subsi; fo-n-r agricil+.urni innpts. the. ey.Pnt. off suhsidvr has fluctuated erratically. I/ From 1955-57 to 19q9-61 the wholesale price index of all commodities. excluding grains, increased by 37 percent while grain prices rose by 11 percant. From 1959-61 to 1963-65 the formpr index increased by 80 percent while grain prices rose by 132 percent. 2/ However, in 1965 the farmers experienced a deterioration in their relative position. The terms of trade index (base 1960) declined from 115 to about 110. - 13 - (5 The small size of farms has inhibited mechanization and limited the growth of agricultural activi.ties, such as livestock and fruit growing. Government policies are not conducive to the diversification of the cropping pattern. C. The Role of Manufacturing 1/ 31 * Ma nufactuiring was a leading sector of the Korean economy. It- growth rates during the first half of the sixties was nearly double that in liie .lat, L9> 0 ValUe added .in manuiacturing increased 1.77 times as fast as GNP during the decade under observation. (See Table 1) This growth momentuma means that Korean, manufacturing expanded much more rapidly than manufacturing elsewhere in the less developed world. Taiwan was one of the iew; countries where -te man-ufactuiing sectuor expnded at a higher speed (14. 8% per amnum) than in Korea (11.0% per annum). 2/ Most of manufacturing industry is in private hands. However, the Uovernrient ha played a very large role in industrial decisions, through its control over the banking system, its approval policy on investments req-uiring foreign exchange outlay, the licensing of raw materials imports and the prohibition of competitive imports. Recently there has been some liverqlizato; and a partial shift from direct to indirect controls. However, the influence of the Government in major investment decisions remains large. 35. The growth pattern of various segments of Korean manufacturing reflected changes in the composition of demand and the impact of Govern- ment policy measures. Industries producing finished capital goods, in- puts for capital goods and semi-processed commodities destined for the construction sector expanded much more rapidly than other branches. (See Table 3) The growth rate of these investment good industries was 1.6', times as fast as the rise of gross domestic fixed capital formatic.n. A fair measure of import substitution was achieved in this area. Consomer good industries, c'n the other hand, were much less buoyant because consumer exPe!nditures increased relatively slowly and because the process of dis- placing imports was exhausted by the end of the 1950's. Production of manLfactured consuLmer goods increased 1.40 times as fast as consumption outlays duiring the whole decade; this coefficient dropped to 0.93 during the sixties. The output of manufactured branches classified into the category of intermediate goods industries kept pace with total manufacturing oroduction. Here too there was a substantial increase in the share of local prodluction in the total market, at the expense of imports. 1/ Based on deta:Lled analysis in Volume V. 2/ Accor-ing to the index of industrial production. See Table 3. - 14 - _m abDj Il e 3' Drc04mTz PArTES ATmn GOMTP(ITTnT\O nOF nTUTPTTT TM MiANIPA(TIURTTHG Rate of Growth Share in Total Value Added -1 5-5E E7 4to Actu-4-L A LTo-rma n I/ -L -.- LAI ~ ~ - ( 4 - 1- Branch 1963-65 _ 1F ( -- I., iD-aI l,, Investment Goods 13.9 22.9 24.2 Transport Equipment 13.8 4.7 Electric Machinery 30.0 1 11.9 Mcchinery 2.1 3.3 ME~tal Products ]2.0 2. Basic Metals 14.2 2.7 4.0 Non-UIetctlic lMinerals 16.0 8. 3 8.3 Intermediate Goods 11.4 36.8 29.3 Wood 6.1 2.7 4.1 Paper 19.0 3.2 1.2 Textiles 6.2 l6.6 14.4 Rubber 11.3 2.4 0.9 Chemica:Ls 23.0 6.j 119 87 Petroleum and Coal ? 5.1 11. Constixmer -Goods 6.6 38.3 45.3 Food 5.1 13.1 ; Beverages 6.1 6.6 y 30.0 35.5 Tobacco 7.1 10.3 ) C:Lothing and Footwear n.a. 3.6 5.7 Printing and Publishing 13.0 3.8 2.1 Leather and Products 1.3 0.9 2.0 Total M5anufacturia& 11.0 /1 100.0 L 100.0 /2 /1 Corresponds to growth of value added in constant prices of 9.4 per- cenn; ner annum. See Table 1. /2 Tncluiiring other rnanufacturinpe not classified above. /'3 For eplan.ation see paragraph 37 in the text. Sou.rce: Vo -.e V - 15 - 36. The growrth of the man1ufacturing sector *wmas stimiulated by the process of import substitution. Furthermore, in recent years a phenomenal 4v.4 rnnJ- manufa^t ured e,ort - provraAded adii + nanl -. pet-.C Wheras during the mid-1950's the export market absorbed 0.4 percent of gross out- putA., tlJiie correspondA 4 ng proportjL-ion lin 9I 6J ) was 6.9 0 percent. (See Chapt IV for analysis of manufacturing exports and imports as wlell as related JJ.L_LL,y i~L~*J 37. Economic development dUurinlg the last decaude has enhaLced the importance of the manufacturing sector in the overall economy. The share of value added in this sector in GNP increased significantly -a-ld now stands at nearly 20 percent. (See Table 1) Manufacturing played a consideracbly bigger role in the norean economy than one wouLa -normally- expect in a country of 29 million people with a per capita income of less than. U.S. $90. 1/ Not only was Korean manufacturing relatively large in size but the composition of its output among various branches displayed signs of premature development, considering the size of the domestic market for industrial goods. For example, the share of consumer good industries in total output in 1965 was less than i"normal"! whlle the share of intermediate good industries was above "normal". (See Table 3) Although the Mission does not attach too much importance to these deviations, they are instructive from the standpoint of understaniding the prelsent Korean inclustrial structure. 38. Food processing industries in Korea are relatively undeveloped in terms of production, although sizeable investments have been made. The rate of capacity utilization in some of these branchles (wheat flour, refined sugar, canned fish) was extremely low despite the fact that the voluime of food consunption increased fairly rapidly in recent years. The Mission was unable to offer a satisfactory explanation for this enigma,. To some extent, it may reflect Korean tastes for foods processed at home rather than in the factory (fresh fish, kimchi etc.) and the large non- monetized sector of the economy which subsists on food grown on the farm or caught at sea. Processing has not developed also because transport and power facilities in rural areas are inadequate. The negative deviation for the clothing and footwear industry was probably more a statistical phenlomenon than anything else. 2/ 1/ This conrrusion is hased on a cross-section regression analvsis of a sample of 53 countries (1953) and 42 countries (1953). The coefficient of the "relative degree of indnstriq1i,2tiAon"1 for Korea in 1965 is 1.404. Regression equations have also been formulated for the distri- bution of valuie added nm.ong various mannufactuHring branches= Se IUN: A Study of Industrial Growth, 1963. 2/ The negative deviation for the clothing and footwear industry was almost wholly offset by theposiiv deito forI text - I6 - 39. Thae com.p:Lex of inter-industrial rela~tions in Korea were rather well developed. According to the 1963 Input-Output Table, nearly half of t+ n MO" ~, ~ m--r- -rA,' ~~ Trn'Z Ir.rnQ,iM A rl j.r+M-A rqmrift'iv- o r )v rlf oa p-mL.ac'duct.on was Lħ .L-*I5 QJu or solJ1 to o-ther sectors in the form of producer goods for further processing. IPI, on- Jn oSe r c n on-+ - h A s Yc n . . V, - h o nn+.n a e nl 1 T Tr * P 1I ; Y-r -; n c: 1956, 17 percent and India 1960, 50 percent. Despite a surprising high sJlħa- oL .LntIerme iate goLAd pJrouctAionUL , flLJCħ man 4 actur-ng was L4O vly dependent on inputs imported from abroad. In 1963, imported inputs, vaLueu au the actual exchanigL e r1-at[e, were 2V pe n of ttl [-w erar semi-processed items purchased by manufacturing industries. If these inports were re-valued at a more realistLc tx1U1inge rade, then the above proportion would be 33 percent. 1/ Dependence on imports was particularly high in the petroleum, rubber, wood, chemicals, textiles and metal indus- tries. These high proportions reflected, in large measure, the paucity of Koreals natural resource endowment - both agricultural anrl mineral. 40. Although investment goods industries expanded rapidly during the last decade, they are still quite limited in size and character. This is particularly the case of the basic metal industry. For example, Korea's iron and steel industry consists of several units of sub-optimum size which are based on smelting scrap. These productive facilities are not equipped to produce structural steel, large plates or steel alloys for which there is some demand. The industry is also handicapped by heavy transport costs; pig iron is transported from Sanchok in the Northeast around the whole peninsula to Inchon on the West coast. Similarly, the machinery indus-try is circumscribed; nearly twTo-thirds of its outpult is produced in small units employing less than 50 workers each. 41 Growth of the manufacturing sector during recent years absorbed more than one-fifth of total fixed investment in Korea. (See Table 1) About 9 percent of manufacturing investment was carried out directly by the Central Government. Another 5 percent was financed by equipment loans from the organized banking system, largely from the Korea Recon- structiorn Bank (KRB). 2/ Interest rates charged by KRB before the recent reform wfere less than 10 percent on a nominal basis and negative on a real basis. considering the rate of price inflation. L2. There are considerable doubts about the way in which manufac-' turing investment was utilized. The incremental capital-output ratio, as recorded in official data; (see Table 1) is certainly not high by 1/ Details are shown in Volume V. 2/ Increase in outstanding loans for equipment to the manufacturing sector as a percent of fixed investmgent in this sector. On the basis of gross lending, the importance of the banlcing system is mur.i l nl -. j r X,--nl a TrT?Q ---- 1 onA4nn fPn- a.nnr%mnrn+ Au.,7 yyer 1962-65 was nearly 12 percent of fixed investment. - 17 - international standards. And yet, considerable excess capacity is known to exist in several industries - food processing, parts of textiles, rubber and basic metal industries. Admittedly, data regarding the rate of utilization of installed equipment are far from reliable. In some cases, for example. pig iron and canned fish, the capacity figures are too high in so far as obsolete and unserviceable machines are included. In other areas - se=ents of the food, textile and rubber industries - idle capacity is simply a reflection of overinvestment in relation to the size of the market There may also be instance - plastics, metal products - in which the unavailability of imported inputs caused a cut back in the producti-on sched,_Oe. 43. The quantity of machinery and equipmentħ nrobablv increased faster than employment in most branches of manufacturing during recent years. The statistical evidence is weak; data on fixed investment by bran,ches is not available and employment numbers may contain errors. 1/ ~V LIL.Sf4 ~ ~ , 4.+jith nrdct-nproce.ss ivas Neverth,eless, the Miss-lon's t,.pression was tha+ eprouctn k wa gairLing in capita] intensity. The ratio of the horsepower of productive equipment to emnplcoyed workers increased in all branches, except beverages printing and metal. manufacture. 2/ 44. The capital-labor ratio seemed to rise despite the fact that wage rate,,, extraordinarily low to begirn with, barely lncreased ir ters of constant price,s. During the last five years, real wages in manufac-- turing actually declined by 6 percent wnile value added per worker rose by nearlr 16 percent. Therefore, we might conclude that the rise in capital intensity was induced not by movements of relative factor prilces but by changes in composition of output among and within branches as well as by the adoption of new technoLogy. 45. Profit rates secured by manufacturing concerns were fairly high. According to the Bank of Korea's sample studyr, net profit as a proportion of net worth was 23 percent in 1962; a rate considerably higher than in most other sectors of the economy. 3/ Attractive profits / Manufacturing employment in 1964, according to the KRF sample survey, was 377,000 compared to an estimate of 670,000 derived from EPB's survey of the Economically Active Population. / See Industrial Censuses of 1953 and 1963. 3/ Apparently the profit rate declined in 1963 to 19 percent and in 196h to 15 percent. The Mission suspects that these declines reflected accounting changes, such as an upward revaluation of net worth. This theory is confirmed by observing the ratio of net profits to sales; 7 percent (1962) 9 percent (1963) and 9 percent (1964). Tn 1963, net profit as percent of net worth in other sectors were as follows: Trade 26 percent, Mining 15 percent, Construction 14 nercent, Transport 5 percent and Electricity 3 percent. - 18 - partly resulted from the fact that the exchange rate was undervalued, that the dependence on imported inputs was high, that many manufacturers enjoyed a vrariety of -tax exemptioris or concessions, that interest rates charged by organize!d banking were low or negative and that international competition was rendered impotent by various restrictions. 46. Elow did recent economic reforms - the devaluation and the upward adjustment of interest rates - affect rates of profit in the manufacturing sectcr? Unfortunately, the iHission was not able to provide a definitivE answer to this fairly important question. The devaluation, undoubtedly raised material costs, in terms of won, for many industries. The impact was much greater for the rubber, plywood, chemicals, textiles and metal industries than for the rest of manufacturing. Firms which imported directly at; the undLervalued exchange rate now had to pay higher won prices. Other manufacturing concerns who purchased foreign materials through Korean tracding companies were already payingi what amounted to post- devaluation prices; these were less affected by changes in the official exchange rate. although the process of adiustment must have varied greatly, the Missic,n ventures the generalization that increased costs were nassecl on to the consumer in the form of higher nrices. in most cases. Dluring 1963-65, wyholesale prices increased as follows: rubber oponoF: On-8r0 nAr-.,ntn. hP1imir.nlh 1n nPrr.nt._- tytiAlps 73 nprcont. .nd mptal products 72 percent. D. FisheriesQ: a Basckuyard Seector I/ 47. The fisheries sector is large, providing a livelihood for 1.2 I.IlJi.on people Wihlich iL abut 4 percent ofL lulh IotaL poplao . H ever, there is a large degree of underemployment in this sector. Small wherez incomes are low and jobs are scarce, this is significant. According to the narro-wer definition used 'uy the Survey of the EuunmUi1ically Active Population, fishing only provides 2 percent of total employment. (See IaulE L) 4o. The back-wardness of the sector is reflected in extremely low productivity levels. Value added per worker in fishing is far below that in agriculture and less than 40 percent of tne economy-wide average. (See Table 1) The low level of productivity is, in the first place, due to a lack of capital. The fishing fleet is small in relation to the number of workers in the fisheries sector, the boats are small (3.1 tons on average) and only half of the tonnage is powered. Moreover, fishermen are lacking in knowledge of modern fishing met Dds. Although there is probably a widespread wrillingness to learn these metihods, the curriculum of fisheries schools, of which there are many, includes too little practical instruct-ion. Fisheries education is also in need of greatly increased budgets for equipment and staffing. l/ Based on detailed analysis in Volume IV. - 19 - 49. The development of the fisheries industryJ is also hampered by the fact that marketing facilities are poor. The fish markets are mostly ,-,..,4 - and a high degree of w.aste an.d loss in q uait. oncnurs through rough handling of the fish and inadequate preservation. The facilities for fish turansportabtiion sn _ hn++Uibrt e J,,i equai11,y defiGejient lead-1 n43 to further waste, and deterioration of quality. Because of the lack of proper preservation and distribution facilities, the trade prefers to carry minimum stocks. This often leads to shortages and very high prices at -the ultimate selling point, regardless of the fact that fish may be abundant and very low priced at the landing point. As in many developing countries, -the price spread froml fisherman to consumer is very large, at times ranging up to 250 percent. This price differential is entirely absorbed by middlemen who dominnate the fish rmarket. The result has been a very wealc economic position of the fishermen who are Irithout funds to invest in more modern vessels or equipment. 50. During the last decade, there has been a steady increase in fish! production by about 6.5 percent a year. Since 1962, -there has how- ever, been an acceleration in the growth of production to 10-12 percent a year. 'v Total landings in 1964 amounted to almost 600,000 tons. The most, rapid increase in production occurred in aquiculture, especiaJ.ly in oyster cultivation. The acceleration in the growith of production during recent years is partly due to the program of general improvements in fishery conditions under the Government's First Five-Year Plan. This program included improvements in communications equipment, motorizatlon of vessels, modern fishing gear, and the development of tidal flats for oyst;er and clam cuLltivation. The program was fairly modest in size but implementation during 1962-65 was on schiedule and for certain items, ahead of schedule. A further factor in the increased fish production is the expansion and to a certain extent, the modernization of the fishingr fleet. The total tonnage of the fleet was declining slowly until the end of the 1950's, but since then, it has risen from 107,000 tons in 1960, to 167,000 tons in 1964. The progress in modernization was not very impressive. according to official data which are subject to many defects. According to these statistics, the share of powered vessels in total tonnage of the fleet, rose from 42 percent in 1955, to 52 percent in 1964, and the average tonnage per boat rose during the same years from 3.2 to only 3.4. 51 . Fish processing; of declining importance because of growing consumer preferense for fresh fish, underwent a s ignificant change during the last few years by the introduction for the first time of frozen fish. By 1964, frozen fish amounted to 30 percent of the total output of processed fish. Ahout half of the frnozn fish is ernorted. There was a corresponding decline in the output of dried, salted, and cooked fish. 1I/ The gr-vw- U. ph-s-a -ol.e bears little reklatlon to- vlue-added figures in national accounts. See Table 1. - 20 - 52. o mrpotan.t new develonTnent in recent years is the cquisition by Koorea of vesse:Ls suited for distant water f'ishing. By the end of l1965, 70 of t.hese vesse&Ls had been acqunired and 70 more twilt be delivered during 1966, mainly financed byr a 40 million loan to the Korean Government by a French-Italia on -or-iM. The vessels, longliners and traw_lers_ are engaged in tuna fishing in the South Pacific and off West Africa. Since the vessels now. fishing have mostly been in operation for less ,on tw__) years, it is still early to form a judgrnent about their economic performance. Daily catch r-te- ha--ve -enerally equalled and in some cases exceeded thnose realized by Japanese and Chinese (Taiwan) fishermen on the same grouLnds. Given the Koreans' lack of experience, this is encouraging. However, total operational costs are still on the high side and the debt service on the suppliers' credits which financed the p-urchase of these vessels, is gener- allyr heavy. The potential for reducing operational cost is probably good because of low wTages and great willinigness to work of the cre-wma,en. E. Electric Power: A Bottleneck Removed 1/ 53. The Korea Electric Company (KECO) was established in its present form in 1961, after the merger of three companies. The Government onms 70 percent of the share capital. In addition, there are more than 32C independent power systems operating in rural areas; these account for less than 1 percent of total installed capacity in S. Korea. N4o statistics are available regarding power facilities owned and operated by industrial concerns on their ow,Jn premises. 54. Nearly 90 percent of electric power capacity of undivided Korea was located in the North i.e. above the 38th parallel. Therefore, the Republic of Korea started its independent career with a tremendous gap in its infrastructure. Power consumption was rationed for the best part of the last decade. The First Plan singled out the "power crisis" as one of the most serious bottlenecks impeding industrialization. 2/ DLring the plan period, installed capacity was more than doubled. (See Table 4) More than 70 percent of present capacity consisted of thermal units; many of rather small size. Although a few thermal plants used oil, the main soI'rce of energv was coal. <5. Power consurnption in the manufacturing sector increased much more rapidly than in other parts of the economy. (See Table 4) Electricity sold by 7˘ECO to manufacturing concerns increased twice as fast as total manufacturing production; partly because manufacturing firms substituted KECO suT -- -factoryr power facilities. In recent 1/ This section is partly based on the report entitled "Korea Electric Power Survey" prep-ard for U.S. .i ission in JKorea. 2/' ROK, Ounu-ary of the First Five=Year Econo-mic Plan 1Q62-66j n. 11. - 21 - T .l PIiCĥ,Tt't VrTQT/ThTDTrlf;'.T AMTT PADW'ITTV I a U.L e L~ I /VV'.L -,0JħLVJUħLI.L ħL CI X1' 4 UMJ SVJ9. I1d.W ..1 A au. Patern of Ct ,onU..J.)tioL PAverage Average Growth Compositio:c. Category 1956-57 1963-64 Rate (- 1963-64 (million KWH) TOTAL 709 1,864 14.8 100 Industrial 368 19178 18.1 63 .LHanufacturing 27 1, 00O 20.0 Hlining 65 147 12.4 8 Agriculture 25 25 0.0 1 lion-Industrial 340 687 10.6 37 Government 105 187 8.6 15 Residential 125 296 13.1 16 Source: ECK% Economic Statistics Yearbook B. Expansion of electric power capacity 1950 1961 1965 /1 (000 K1,') TOTAL 230 367 769 Thermal 167 22L Hydro 62 143 215 ,/1 Sep tember Soui-ce o EPBa Korea Statiscioal YearbooTs Korea Electric Company: The Status of the Company - 22 - year , acO.at.. a unts for morn- thLan 50 r nt OrL5+n.Ar total ciJr The textile, lood processing, chemical and paper industries are the bulky consum,=,ers. '.eidnt ' cono-;rpt4-onn also in----cra +an4 rly -adilny A.t present, about 34 percent of non-farm households are electrified; the correspond iing proputal Uji forI.JjJ.lVA_LJ.J vLlage 11hoAuseholdsJ iJ.0 Less hLanIA 10 pJ ent. 56. Rest-ricti_ons on e c Anp 1964. This was one of the notable successes of the First Plan. However, a number of problems remain. The first concerns Korea's pattern o-.- utililzation of natural energy resources. (See Chapter VI) The present price relation between coal and oil encourages the power company to use coal in thermal plcmts. The fact is that, on the one hand, recoverable reserves of anthracite coal are fairly linited. On the other, tne pressure of"' demarld for coal wlill grow rapidly as the household sector substitutes briquets for wood and straw for domestic heating purposes. Also, further growth of' metallurgical industries may require increasing quantities of coal. The question then is whether the Government should reconsider its price policy in the interest of making the most economic use of coal supplies. 57. Tlle second problem relates to rural electrification. The KECO, pre-occupied with expanding the major power network, did not concern it-- self with providingr facilities in the countryside. Meanwhile, public funds on a grant basis were used to finance the construction of a large number of petty power systems operating independently of KECO in rural areas. These facilities have catered to a genuine demand for electricity;- outside the cities. The problern is that these small plants, described as "micro-hydros2 are extremely expensive, shortlived and unreliable. 1/ The (Governrment should reconsider its approach towards rural electrifi- cation. F. The Transport Network 2/ 58. Korea has a relatively simple transport network consisting of about; 3,000 Im. of railway lines, connecting most major economic centers of the countr,r a few paved highwzavs in length totaling 1.660 -km. and a number of ports of which Pusan and Inchon are the most important. The olut.nut. of, +thet trnnanprn' qp1 n.r rnt ; rapid rate nf' 11 7 nPrcent; a year; more than twice as fast as GNP during the past decade. (See Table 1) Howjevrer clue to low rates, especiYally for railwayir n engers ar!ir highway transport, there has been a drop in the contribution of t-ranspr-ot to GTNP, measuredA in rh4-o ices ,r ng +Jhe sorndr hanlf' of the 1950's most of the Government's activities in the field of trans- ---+- w.,-ve A4 -.00+eA .+4 ,.c-n4r 4h niaO A,,.,cce4 ,4,a in +4-o port~ wr A4 rected - at es - -i g the severe dai.46es - a - the 1/ S'ee USO1M Survey ... op. cit., Vol. II, pp. 333-334. 2/ This section is partly based on the preliminary report of the IBRD Transport Survey Team-. - 23 - Korean ar ' Dri no tlħe neriod of the First Plan, the Government aimed at modernization and a modest expansion of the transport system. The emphasis was on development of the railroad. Development expenditure on the rail- road during the plan was almost six times the expenditure devoted to higrh- wa,,.y develop-,emrit nrd foAlr tAmes the exrpenditure on norts. 59. The- Kore m. T\Tlna+j l1 Rail-irai established during the Japanese occupation and wholly owned by the State, is the only railroad in Korea. The railroad lines cover the country fairly well, although certaiii ruraL areas and provincial towns, especially on the East coast have no connecA;ion. The mXain. emp lshasis n lirne construction was initially on the link between Japan and ]4anchuria through Pusan and Seoul. This line wJhich connects a nubmer of other important cities as we" ,is still the ma yf railroad. The volume of passenger and freight traffic increased during the 'Last decade at an average rate of respectively 7.5 percent and 9.5 percent a year. During the 1960's, however, the rate of increase has acceLerated to respectively 9 percernt and 10 percent a year. This acceLeration is connected with the speed-up in the overall growth of the economy.. In the case of passenger traffic it is moreover due to low rates. On average, passenger rates increased by a third between 1960 and 1964. ITholesale prices, however, doubled duruing the samLe period. The increase in freight rates has roughly been in line with the general increase in prices. 60. The rallway program during the First Plan consisted of the cOn- struction of new lines, dieselization and the expansion of rolling stock. About 250 km. of new lines, chiefly intended to provide better connectiDns wzith the coal and ore mining areas in the Northeast wfill be completed by 1966. Provision was also made for double tracking part of the important Seoul-Inchon line. 61. In spite of substantial addition to stock, largely financed by U.S. assistance, the railroad has been in a very tight rolling stock position ever since the Korean Wlar. By maintaining a good state of repair and long average daily hauls, the railroad managed to prevent excessive delays in transport. As far as locomotives are concerned, the railroad is expected to complete the dieselization program by 1966. 62. The target in the railroad's program for the local production and import of passenger coaches will also be fulfilled by the end of 1566. This has made it possible to retire almost all of the converted boxcars which had been in use since the Korean War. The import of freight cars, has proceeded on schedule, but the local production of freight cars is behind schedule. 63. The role of highway transport is much less important than the role of the railroad. The motor vehicle density is very low, even for a couzntry at Korea'I: stage of develomnent. At the end of 1964 the motor vehicle fleet consisted of 5,400 buses, 18,000 trucks and 15,000 passenger cars. Duri.ng recent years, (1960-64) the rate of growzth of the fleet has - 24 - been sloI: 6 percent a year was th-e average eu'ual increaCse ir. th +n. of buses and trucks and only 4 percent in the number of passenger cars. A r garge p ar t o,f t hi i -, '-1 11 l .-leetu conssists ofP used s-ry materia , often with reouilt bodies. The import of motor vehicles is subject to speciaL icesn -nd so-- fax -t- P, he n,.urber ofP licenses-issued has been ve., -mall ~~A _L1 O41IL ,~J .J.C, ULL~ iJ1JJ LJ -LL-ML U .L.Q.LL~UU 11dLC LJUU1L V0_L. J1I -L.L. 64VLA. IvlL , u.n 1o.LhL1J. hihwy syster,. ra.dA.LVLi.lly Lhas iidaU a 'LoVJ priority in Korea. At the beginning of the First Plan there uere oiily UV Wl.. of pavedI hLghdays, mostly shorti s ,UL1, aund Seoui major cities. The plan aimed at doubling the length of paved roads mainly by improving and pa-ving the Seoul-Pusan nighway and the highway from Seoul to the East coast. In addition, the (revised) plan included the repair and construction of^ highway bridges over an aggregate length of 17 kn. and construction of 120 km. of industrial roads. On the whole, this not very ambitious plan is progressing well. 05. Ports are an important part of Koreais transport system. Having no trade relations wfith the North, South Korea is an island from the economic viewpoint. Given the dependence of the economy on foreign trade, the ports play a vital role. A considerable amount of coastal shipping adds to the importance of ports. The country has many natural harbors on the south and west coast but fewer on the economically less developed east coast. Pusan, by far the largest port, handling 4-5 mrnllion tons of cargo a year, has alongside berthing facilities for ships up to 20,000 tons. Inchon, the second port, suffers from very high tides. It has alongside facilities up to L,500 tons in a tidal basin wh-ich, howTever, is being used almcost exclusively by the U.S. Army. Ports of growing sigraificance are Ulsan, because of the refinery complex, and Mukho, the coal port on the east coast. 66. The total volume of cargo handled in all ports has doubled during the last fcur years 1/, reaching 11 millIon tc&ns in 1965. The increase in the dollar value of foreign trade during the same period w,s only about 70 percent. This is dlue to the greater bulkiness of foreigrt trade. On the export side there has been a large increase in coal and iron ore shioments. On the import side there has been a shif't fromn finished uld intermediate goods to raw material imports. The ports section of the fiirst five--year plan aimed at imrproved efficiency and increased capacity of the major ports or ccnstruction of facilities such as break- waters, jetties. and ouav walls. No nrovision was made for additional operating equipment except in Mukho. The plan also provided for the construr'cion of inr1ustrial harhors at .llnsn anrd Ghinh2e . Tn order to enable fuller utilization of existing port capacity the program provided for dredging nf Q millinn in3_ TJnfrr+.inn+.lv +.he MNission doepq nn+. knor the extent to which the plan has been executed. 1/ average 1959=6' to 1963- - 25 - III. PIBLIC SAVDIGS, PRIVATE SAVINGS AND FOREIGNI AID (1955-65) A. The Overall Perspective 67. The Korean savings rate was abnormally low throughout the past decade; even allowinLg for a significant downward bias in the statistics (see paragraph 20). A sizeable inflow of foreign resources helped to finance a ris-ing rate of capital formation and to accelerate income growth. Whether there was equal success in raising the Korean savings rate is problematic. Although some improvement did take place in re-nnt years, it was not as striking as in Taiwan. 1/ 68. How much improvement took place in Korea is difficult to measu.-e prec:3e~ly. Ter4-1-,+v,he I , it s4 clea +hhat rel JGT -ereeased r apidly while the dollar value of foreign aid (roughly measured by the deficit on the current accont o- the balar.ce o-f payments dec1ned. Char+v TT shoy.s these relative movements expressed in termis of index numbers, based on three year movrng averages. 2/ Whi4e GNF -ncreased by 52 percent, the dollar value of foreign aid declinede by 16 percent during the period under observation. Thi'is result was ach-ieved part-ty through lueltter resource a3llocati4on polJcEes (see paragraph 20) and partly through a fall in consumption relative to total resources ava-lable to the Korean econon,y. The conLtribution of these two factors cannot be segregated without overhauling the entire set of national income accounts t,hrough the substitution of realistic excharnge rates for those presently in use. 69. Savings can also be viewed as a financial flow determined by the prevailing structure of prices, interest rates, foreign exchange rates arid incomes. In this sense, savings is best measured by the present version of national accounts, expressed in current prices. Three year moving averages of gross investment, the current account deficit, gross national savings, pufblic savings and private savings are plotted on Chart I. 3/ All these variables are expressed as a proportion of GNP. This chart shows that the gross savings rate has moved in the range between 2 and 5 percent for most of the period. An upward movement can be seen from the average centered on 1961 (2.3 percent) to the average centered on 1964 (5.8 percent). Despite this rise, the present level of savings is far below the target set by the First Plan. 4/ 1/ T'he rate of savings in Taiwan climbed up from less than 10 percent in the mid-fifties to more than 20 percent in 1964. 2/ The use of three year moving averages helps to focus on the movement under- lying erratic changes in imports, the current account deficit and GNP. 3/ Gross national savings are measured as the difference between gross invest- rn.ent (fINed and inventorv) and the deficit on the current account of the balance of payment (import-exports). 4/ According to data in the Original Plan document, the proportion of con- sumption to C-NP wTas to fail from 101.81 in 1960 to 88.n w in 1965. tb961 2£961 961 1961 0961 6'Q61 9961 L961 99151 SONIAVS dC\1D3S oi18ledb.., O ~~ _ - - 1 - -_O ,/0g + - ____ _____NIAVS_ _INIOIV PJ SS0_ _ __ ___ __ _ _, --' <,o~~~~~~~~~~~~~~~~~~~~~~~~ _, == -~~~~~~~~~~~~~~~~~~'~~~~~-.----.. -- _ __ __o_ __ _ _ %S +,,,c _f,___ 1%9 + SONIAVS 801D3S 31V/AI8d %O 1+ __ I ek '' ''/0 + i101II30 iNnooDDv 1N3U8nD o _i _ / lN--IWlS31/Nl SS089* _ 0/001 . +0-- _ I. __/0 0 t 1 1 539 Jldi~~~~~~~~?3AV SNiAOW U83, 33Ulril |%OZ + L lI! -L%07 +4I tS33 CI Rld1N -4 A no dN9) SO % St lN3WYLS3ANI (INIV S;9NIMS, SOl S.lt:-INOdWyoD)l iI9Ii JO I NflO.NY3YYi SNANNJ 9NYiONVf Nll3" I0 -~~~~~~~- CHART Ir KOREA: RELATION BETWEEN GNP (1960 PRICES), COMMODITY IMPORTS (U.S. DOLLARS) AND CURRENT ACCO'wNT DIEFIC:T (U.S. DOLLARS), I9m !ons1 (INDE)X. 1956'100) r 160' -' I 0 1C THREE YEAR MOVING AVERAGES 150W-- 1 1 1 A-150 IA I ~ I I1 _ _G 1 130- 134) 12C _ __120 IMPORTS a.. . I O() f- *-w... >sA I . / 100 gn CL 8 0 f .. : -CURREun NT ACCOUNT1 .. .-- | ~~~D EFIC IT 7 C) i : *I70 6 ( 10 6 0 1956 1957 1958 1959 1960 1961 1962 1963 1964 113RD -30091 N~~~~~~~~~~~~~~~~~~ / Chart III - -~~~ KOREA: PUBLIC REVENUES AND EXPENDIITURES, 1958-1965 (AS % OF GNP) '8't r +t: 13% II CURRENT EXPENDITURE I + ,4% L'- " \'- + 14% / CU~MRRENT R-EVENUE \ + 121f0 - / I \\ +12% I/ A X / + 10°%ZoX i ~~-; + F% A / __-- - s - X-CEA'PiiST;CAPITAL ~PENDI'ilJ URE + 6cno -f ' ' |4% I COUNTERPART FUNDSO- - L 24Yo ~ 0 --NET BORROWING 2%1y +\ i -2% ON ~~~~~~~~~~~0 \ ~SAVINGS ON CURRENT ACCOUNT I 4 17' -^o|!0!!!_ 4 --' 1958 1959 1960 1961 1962 1963 1964 1965 IBRD-2998 - 26 - 170 Wll 1. -h rate of saP E so low -- '1-, orea?'T - 4t s nal cm per capita is certainly low (less than $90) but there are manry countries - India, Pakistan, Sudan, Nigeria, Uganda, TanganyLka - with iowt or eq-uai per 4i incomes who have achieved higher savings rates than Korea. Purthermore, Korea has a relatively' large industrial sector -W-uich sho-uld, -i theorly, facilitate the accuriiulation of savings. The reasons for low savings in Korea wvili be examined separately for the public and private sectors. B. Public Savings 1/ 71. Unlike a number of developing countries, Koreals pu?b-lic sector does not make an important contribution to the flow of savings. In fact, Chart I shows that public savings were negative till recently. The size of these budgetary de,ficits, relative to GNP, was shrinking and a positive balance was achieved for the first time in 1964. This was a notable achievement; it illustrated the Governmentts determiination to follow disciplined financial policies. However, equilibrium on the 6frrent account of the budget was secured not by raising public revenues- but rather by a very sharp reduction in current expenditures, relative to GNP. (See Chart III) The nature of the equilibration can be better understood by identifying, seriatim, the factors operating on the revenue side and the expenditure side. 72. The ratio of public revenues to GNP described a hill-shaped curve with two peaks. This ratio increased from less than 10 percent in 1958 to peaks of about 14 percent in 1960 as well as 1962 and then fell to 10 per- cent in 1964. The dlownward slope in recent years could be explained in terms of thae following factors: (1) erosion of an important part of the tax base i.e. imports:; (2) discretionary reduction in tax rates and the granting of exemptions; (3) non-adiustment of snecific tax rates and Governm,lent price,3 in the context of inflation; (4) systent of land taxes. 73. Import taxes - customs duties, the foreign exchange tax, commodity taxes on imported r t.rmq - accouint&d fnr 41l pereent of tntal tax revenues in 1960. Revenues from these taxes lagged behind GNP partly because of irhport substitution and partlyr behause of aconsiderable reduction n the average effective tax rate. The dollar value of inports increased at a much slower pace than ra C ; - a tariff schedulas, fojloTinr, the devaluation of 1961. Textile and ply,.;ood ex-or)ters T7- --t.- . ULLU ' U at, Vil £[I4OIJ cr.Uo1 -'a; oU Ul2e dil . * i.Lo- _,ether, the avera e ta.x, revenue, per dollar of imports, declined from _~J , -_ 'I 4rl - . - - _ i / I J14 -.I Jil 4.7J d LJ L)j VUILI ħ11 _L/ULi. 1/ For a detailed analysis see Volume VII. 2/ C;ounterpart, fund receints hy the GovernmPnt are treatpe in this report as receipts on public capital account. - 27 - 74. Although thp manufactiuring sectnr axpanded ata muce-h faster rate than the total economy and although the rate of the corporate income tax was raisedj the revenue yield frnm this tnr did not show much buoyancy. This was because of widespread evasion and the pro- liferation of ITgal exemptions. The revenune los.cs: fro-m oexmntions wnq estimated as 37 percent of the potential yield of this tax. The stratesiyv for frtiniai nfllowedt drii-;ino this peoriodi pnroved fairly costly in terms of public revenue foregone. The emphasis of polic wasn A 1- * snt inLS fr^dfl *4 -ian hIn onnn raas the savings rate. 75. The agricuLtural sector is subject to the land tax administered 1 L 11L~ L AI ~ Uħ ~ dVl J.6%,VLL LOJ. U 1jJV L.~L L U1 byr Local Gove-r- n S >vre fr,, IQ- sorc avrgd18prcenl ofP agricuLtural income in the early 1960's but more recently this ratio declned J1..3 percant Z. This cdl -Ls relat edLu toV tah OP%UħL!L Uspecifc d g .L the tax on lands growing food grains. The assessment is based on staVndard!! yields valued at currenLt prices. Reve1uUes from this tax are responsive to price changes but not to increments in agricultural pro- ,.AducItiv Th "stanuar'" crop yields have not been revised since i95v, although sizeable increments in productivity per hectare have taken place. The fundamental difficulty in taxing agriculture arises from the largely "subsistence" character of this sector. The land reform has ironed out inequalities of wealth and income. The tax administrator confronts small-sized and scattered farms producing, in great measure, for seif-consumption rather than for urban or export markets. 76. Revenue from the liquor tax, the travel tax, the Government tobacco monopoly, the railways and communication services were adversely affected by the fact that rates and prices determined by the Government either failed to keep pace with the general inflation or were adjusted only after significant delays. 77. During 1965, a vigorous attempt was miade to reverse the declin- ing ratio of public revenue to GNP. A determined campaign to improve tax administration corbined with changes in the foreign exchange rate and adjustment of commodity tax rates as well as coverage resulted in some improvement. Beginning January 1966, rates of the corporate income, liquor and travel taxes have been raised. These are welcome changes. However, the Nlission believes that a substantial tax reform will be necessary to finance the Second Five Year Plan. The Korea tax effort, at present, is far below that of many developing countries at a similar stage of development. 78. The achievement of budgetary balance, during a period wihen public revenues were lagging behind, required a drastic curtailmnent of public current expenditures. The ratio of these out'lays to GNp dropped from 16.4 percent in 1962 to 9.9 percent in 1965. (See Chart III) In terms of constant prices. public current expenditures scarcelv increased at all during these three years. Economies m!ere secured in lefense outlay- probably to a large extent because th e salaries of 'il-tar 4 officers - 7ere not adjusted in line with the rise in the price level. - 28 - .-ious B-, re-ports argeed that Kforee… defense eXnpndituires were extra- ordinarily higP; the proportion of these expendi'ures to GNP has come down consiiderabl-y,- but ruUiay rise a,aLn somewhat wvhen salaries are djjusted 79. ~ThLe aust-erity ," pd"lc sper.ding had -rta--i windesirgalle side- effects as well. First, the civil servant suffered the brunt of the infla- LO-ori. TbEJe rea.L valbue of public s'aries dec" t.ned by ahut I50 percent during 1962-65. The present position is clearly untenable from the standpoint of either efficiency or morale. The senior-most civil servant draws an annual salary equivalent tco U.S. $1337 only. Corresponding salaries in other develciping countries, at lower or equal levels of per capita income, are considerably higher than in Korea. 80. Secondly, unavailability of funds led to a decline in the standard of elementary educat ion. Enrollment rat'ios continued to rise but this quantitative expansion was at the expense of quality, in large measure. Overcrowded classrooms, reduced hours of instruction owing to the do-uble or triple shift system and inadequate teaching materials pose many serious problems 2/. Expenclitures on education, nearly one-fifth of total current outlays, are obviously inadequate on a per student basis. 81. Thlirdly, budgetary constraints interfered with the implementation of poLicies designed to provide incentives to farmers in the form of subsidies for limestone, pesticides and seed distribution. The rate of subsidy varied from budget to budget depending on the release of funds. These changes confused the farmer and the agricultural administrator in the field. 82. The M,Iission concludes that Korea's budgetary equilibrium, at the present juncture, is not at the optimum level of public sector activity. It is commonly recognized that many items, conventionally classified as current public expenditure, are not without considerable developmental significance. Good examples are elementary education and selected agri- cultural subsidies. Consequently, financial balance achieved at the expense of such outlays may turn out to be a false economy. The Korean public sector should generate a growing flow of savings and at the same time finance an adequate volume of current expenditure. 1/ See IBRD: The Current Economic Position and Prospects of the Republic of Korea, August 196h. Defense outlaysas a percent of GNP were about 6 nercent upto 1962. The corresponding proportion in 1965 is 3.7 percent. Comparative ratios in other countries are as follocs: Taiwwan 8.5%; Tsrael 8.0., UAR 7.2%, Greece 4.7" and Turkey 5.0%. 2/ See UNESCO Regional Advisory Team; Long-Term Projections for Education in the Republic of Korea (Preliminary draft report), Bangkok, Hay 396 1. - 29 - C. P-ivate Savings and inflation 83. Savings of the private sector, calculated as the difference between national and. public savings, did not describe any clearly defined trend. (See Chart I) Private savings as a percent of GNP varied betweentr, M perAcent an peA ent, on the basis of three year moving averages. Low savings rates in the private sector may be partly explained xin ermris of the relatively equal distriution of in come and wealth in Korea. Unlike other developing countries, Korea did not have conspicuous concentrations of riches, except perhaps the few families who acquired wealth through manufacturing and trading operations during the last decade. The land reform was relatively successful and the Korean War proved a powerful leveler of disparities in social status andi material well-being. Since poverty is equally distributed, there are few surpluses in family budgets. 84. Available data indicated that corporate savings were growing rapidly. The proportion of corporate profits to national income rose from less than 1 percent in the mid-fifties to about 5 percent in recent years. This expansion reflected not only the familiar transfom- ation in the legal structure of enterprises in the normal course of events but also the redistributive impact of infliation. As men.tioned before, money wage rates tended to lag behind the movement of prices for f'airly long intervals. (See paragraph 44) Consequently, real wages declined during periods when labor productivity rose significantly and there was a redistribution in favor of profits. Apparently, at least 79 percent of post-tax corporate profits were saved 1/. 85. T'he Mission could not establish the realiability of these data, derived from the present set of national accounts. If corporate sector savinrLs really increased to a level of 5's, then the implication is, that other private savinxgs Jere extren:ely small. It is possible that the national accounts underestinate the savin:gs rates of unincorporated business and households. On -the other. hand, ho-yever, considerable dissavln, may take place by household receiving private donations from abroad (2.4% of GINIE in 1965 ). 86. The inflation may have contributed to the growth of corporatiLons but Lt has seriously impaired household savings and the efficiency of orgalized banking as a financial instrument for resource mobilization. There could hardly be strong incentives to make time and savings deposits during a period in which rates of price increase were much higher than legaL ceilings on interest rates offered by commercial or specialized banks. 2/ Under these circumstances, confidence was undernined and 1/ Tnhmparable rates in industrialized countries are as follows: Japan 79 percent, U.K. 55 percent, Germany 68 percent and USA 41 percent. See UN1 World Economic Survey 1960. 2/ The legal ceiling on rates offered by cornmercial banks for time and savings deposits ranged from 9-15%. Similarly, coumiercial banLs could not charge borrowers more than 16-18.5%. These ceilings compare with price rises of about 3CF per year during 1963 and 196)4. - 30 - expecta-lionas were gez-d to I cor4-a, on of t1he nflationar proces A thriving curb market for credit, charging 4-5 percent a month, competed it i i the organized barkiLng systlem. r hes exr-aorurdInay 1ransactionls were not a peripheral phenomenon; outstanding loans from operators on the curb market amounted to a third or half of outustHaing loans from the organized banks. The psychological climate and legal constraints on financial institutions inhibited the habit and attitude of triLft and encouraged instead the speculative tendency. 87. Recently progress was made in controlling inflation. Stabil- ization progrrams for 1963 and 1964, jointly designed by the Korean Govern- ment and the United States Operations I,iission, failed to check prices. Owing to excess liquidity created in the preceding two years and bad grain crops, prices increased by 21 percent 1/ in 1963 and 35 percent 1/ in 1964, despite the fact that money supply rose at a modest pace. The expansionary effect of the credit expansion in 1963 was neutralized by a drastic fall in foreign exchange reserves. By and large, the villain of the piece was not monetary expansion but a rise in velocity of money. In 196'5, the Government attempted to adhere to stabilization progranms with the U.S.A. and the TIF. The emphasis of policy shifted from direct price controls and detailed credit quotas to indirect controls and overa:Ll credit ceilings. Also, monetary policy received reinforcement from other quarters - the budget, the exchange rate and measures affect- ing interest rates in the fight against inflation. Prices increased by about 10 percent 1/ and the Bank of Korea accumulated foreign exchange reserves during 1965. 88. The moderate price rise in 1965 should not be interpreted to mean that the inflat;ionary problem has ceased to exist. There are three reasons for caution. First, the relatively low increase in the wholesale price index in 1965 is influenced by a fall in grain prices. The index for o-ther cormodities increased by 14 percent. Secondly, although the formal scope of price control has diminished, the Government continues to exert considerable pressure on producers to limit price hikes. In the albsence of such pressures, the wholesale index might have registered a bigger increase. Thirdly, the inflationary problem continues to exist at the psychological level. Many private sector groups are not yet convinced that Korea's long history of inflation is over. Confidence in price stability is not yet firmly established. 89. An important step was taken in October 1965 to improve the efficiency of the orzanized banldng system. Leval ceilings on deposit rates paid and interest rates charged by banks were relaxedO Rates on savings denosits were raised considerably, up to 30 nercent for denosits longer than one year, with the result that the value of such deposits doubled1 during five Tr,onnths. A part of this increase probrnhlv r a switching of funds from the curb market to commercial banks. It is also possible that attractive rewards for savi;ngs, not only owing to the -i/ rC.r an ar.al average basiI. - 31 - interest rate reform but also due to relative price stability, have caused people to raise their rate of savings. However, there is no conclusive evidence on this question at this time. 90= Lending rates of commercial banks were raised to 26 percent in October 1965. Even at this high interest rate, demand for funds exceeded the supplvy Also, there wfere no indications of a recession in the curb market. Business continued, apparently at a brisk pace, and the prevailang interest rate did not decline; according to available information. The extraordinary structure of interest rates prevaninr.g now indicates that k.ey elements in the Erorean financial world expect that inflation will continlue. If the Government continues to demonstrate £ir-im,ess anid discipline in financial m atters. then Govern- ment policy should camr conviction before long. - 32 - D. Foreign Resources 91. The inflow of foreign aid has declined in recent years. The current account deficit of the balance of payments fell from an annual average of $301 million during 1955-60 to $264 million during 1961-65. For 1i965 the estimate is about $200 million. Despite this decline, Korea remains one of the major recipients of foreign assistance from offici1 sources. 'r-n 1963; she ranked ninth in the list of recipients, arranged according to the magnitude of total official capital inflow. 1/ Korea is even more prominent in the lit. Of reiipients of foreign aid on conceSsional terms; 2/ she occupies the fifth place after India, Pakistan, Alger-La and Vietnam. Eve more telli-ng is the nomparison Jn terms of npe capita receipts of concessional aid. During 1961-63 Korea averaged $9 commlpar edUEL 'J't lss 4har $3P fo Q - PIV4Y' r all developing comitrieS and aboult. MS -for Taiwan. 92. Grants from the United States and United Nations as well as private donations from foreign zmissionary groups or charities filled the entire balance cf payments gap during the late 1950's. (See Table 5) A large inflow of for-eig resources thus entered the Korean econom.y wirth- out creating any debt servicing obligations whatsoever. liore recently, this picture has changed and long-term official loans as well as medium- term commercial loans have begun to replace grant assistance. 93. In particular, the role of U.S. grant assistance has dininished greatly. From the peak of $341 million in 1957, thlese grants have declnied to a level of about $130 million in 1965. U.S. grant assistance is extenied in the form of Supporting Assistance and under PL 480. In order to support the Government's defense effort and to develop the economy of the country the United States makes annually available through the Agency for DIter- national Development large amounts of aid in the form of raw materials, the most important of which is fertilizer. These commodities are either direct:Ly imported by the Korean Government or by private businessmen, In the latter case, the won proceeds are made available to the Korea Govern- ment. In recent years, the total amount of supporting assistance has come down considerab 2y, from about 9260 million a year in the late 'i950s to an average amount of $93 million a year during 1963-65. In 1966 suppolt- ing assistance will be further reduced to $60 million. 94. A further important contribution by the United States to the Governmnent's budget consists of the won proceeds of the sale of agricul- tural cor3modities which are in surplus in the United States. Korean imports of these comnodities are mostly wheat, barley and cotton. Grants 1/ The order is India, Pakistan, Algeria, UAR, IIexico, Vietnam, Turkey, Brazil, Korea etc. 2/ Foreign aid at less than 3 percent interest rate and with a maturity of over 20 years. - 33 - oNf' +thicz nafur aremAad -trne4 PT. 48,R T-ite I. The aner4ecul4iival cor..= modities are sold in Korea through commercial channels. The U.S. Govern- ment allocates part of the won -eeds (79 ,r0 . 1A as -r&nti to thli Korean Goverrment and keeps the remainder for its own use which inc]luxes a -large ar,mcn -4 oP ech-cal 4-i@&.eo TKo-a c--A a sra'' amount; (1 percent in 1965 and 1966) for the Cooley Fund which finances local cI ec ). U..L .L JUcIJ1 Uto llvauv DUSUNDSt011=1. CL. 48V, 1.t-LU IL a.L1.va lQ reached a peak of $97 million in 1963 and have since then declined gr d a I . . ,.Mi n e..en -2 _ n 4 __ T. LI . għ L * e au agee .L X 17t6 `LS GU; 1ILL-L .V;1 t *Q* LilUEI . U S jLiLC commocdities are also used for a number of other purposes 1/ such as disaster relie, school luunches a-d for payment of wages in food-foL-- work programs. The latter have become very important in Korea. A major portlion of the uplald reclamation effort is based on t Uhe distriuutioL of U.S. wheat flour to laborers. Duri,ng the twelve months ending H,4ay 1966 arouncd 2)40,000 i'iT of wheat equivalent (about $lh million) is estimated to arrive in Korea for this purpose. Table 5: HE Ffl'TANGCflG OF TI; CULRENT ACCOUNT DEFlUXIT (in percent of total) 1955-60 1961-64 1964 Average Average Current Account Deficit 100.0 100.0 100.10 Grants to Public andi Private Sector 101.7 82.6 88.'? Grants by U.S. Government 90.7 67.3 63.3 Grants by U.N. 4.0 0.3 1.0 Private Donations 7.0 15.0 24.6 Loans to Public and Private Sector - 8.9 10.6 (Net D s ursements) Long and l,Hedium-Term Loans - 8.5 12.5 Official Loans - 5.4 11.8 Commercial Loans - 3.1 0.8 Short-Term Loans - 0.5 - 2.0 Direct investment - 0.4 - 0.3 Use of Assets - 147 8.8 2.1i Rrrors nnd Olmi'sions - _0-7 - 1.A 1/ Under T'itle II and III of PL !80. - 34 - 95. Disbursements of official loans financed nearly 12 percent of Korea's balance of payments deficit in 19614. (See Table 5) By November 1965. loan commitments totaled $182 million, mostly for manufacturing and overhead facilities. Most of the official loans (84hc) were made by the TUnited States. Other lenders were IDA, Germany and the United Kingdom. The conditions on these loans are lenient. The AID loans mostly have repavment periods of 30 years after 10 years grace and interest rates of 2 - 2,5 percent (0.75 percent during grace period). The conditions on the mDA loans are even more advanbtageous hut those on the German and British loans are slightly stiffer. Debt service payments on the total of official lo-ns outstandng are low, about $3 millinn a year unti I the mid 1970's. 96. Commercial loans are also coming into prominence. Toan comiuit- .rert Io-z~~iO .*,A-.w byNYAerbr195 otl o mruat n deep-sea fishing. The U.S. and Japan accounted for about $60-70 million acLiaAnd thA ne___l AA1_ -,- P_s-- LI- -rOnA T+,1%r n"rsl CZ-.T4 +,7 -e1 -n -ri sc.LWLj a.LIu Lv.iI; .eIcJ.L . * X Dc41w W s LcC i LLUJ1I U0 ZL .U , J.y -L - - Conditions on these suppliers' credits are, of course, much less favorable iarL a.L rit hUħJ..LLħLe ofi hV.lCħoans. PILLthoughUI U.LV there -s ov the typical interest rate level seems to be 6-7 percent and the typical repay-ment period 5-7 years. According to infoiration obtained i- .orea the maximum debt service obligation on suppliers' credits committed at tne endi of November 1i95 will occur a.VwLU 970I cdLU will aUnt oU abouv $30 million. Suppliers' credits require Government approval and most credits have also receivred a repayment guarantee by the B an- of Korea. Certain suppliers' credit in 1962-63 apparently were approved wi-thout adequate examination, but since then there has been a marked improvement and most projects obtaining approval now appear of high priority. 97. Direct investment by foreigners has thus far been small, about $2 milLion a year during 1962-64. IKlost of the investments have con;e from the United States. Trhe legal provisions for foreign direct investments are attractive (full tax exemption for corporate income and foreign manage- ment remuneration; -iberal provisions for remittance of profits and re- patriation of capitaL). The improved economic prospects of Korea have recent:Ly attracted many potential investors and as a result direct in- vestmenit in 1965 was higher than in the preceding years. A further libera:Lization of profit remittances and repatriation is under consideratLon by the Governzment. - 35 - TV. '4PrMT qTTTrqTTTTTTI MMT MITC TV 7T-1PnRTS A. The Excchange Rate Policy ~~ d. .L ~A-kl -;v Y. hSSt~nn la. - 98. Ihe n.oieab' -e5t ^1 Krasbaa.eofp.-seii (See Chart II) is the result of considerable import substitution and, mr,oe recent]Ly, oLf a sta-4t14ng increse. .n epta4 Tr' 1965 exports of goods and. services financed nearly 60 percent of total imports that, on the whole, Korea's trade and balance of payments policies have produced _Lpreslv- Vt4L-j. ULħC rItly pont out a ,UulJ,ħ of shortcomI,g in the design or implementation of these policies but the fact remains that, in a rough a-nd reauy way, they proved effective. Oe of the major policy instruments was the foreign exchange rate. 99. The exchange rate increased from 50 won per dollar in August 1955 to the present floating rate of 272 won per dollar in a sries of devaluations. Broadly speaking, these moves lagged behind the increase in the domestic price level and marked undervaluation of foreign 'ies persisted right uptc 1964. 'Jhether or not this undervaluation was delib- erately contrived, it did have the incidentai effect oI obtaining mOre United States assistance in dollar terms for defense and budget support purposes thcn would have been necessary under a realistic exchange rate policy. 100. The present exchange rate policy had its beginning in liay 1964. At that time a decision was made to move towards a realistic parity, to abandon a number of multiple exchange rate practices and to liberalize gradually some of the quantitative restrictions on foreign trade. in 1Iarch 1965, K'orea established a floating exchange rate system i.e. the determination of the rate as the price which equated demand and supply of' foreign exchange certificates, traded in a limited free market. These certificates can be bought by anybody without limit. The validity of the certificates is only 15 days, however, and they can only be used for purchasing imports. They cannot be used as collateral for bank loans. These limitations on the use of foreign exchange certificates are designed to prevent speculation. In principle, the exchange rate is allowed to fluctuate freely but the Bank of Korea can intervene by buying certificates to prevent the exchange rate from becoming less than 255 won per dollar. Contrary to expectations, the rate has depreciated by only 7 percent in the year since the certificate market started operating. Apart from the above mentioned institutional limitations on the use of certificates, the slow rate of depreciation is due to the relative stability of domestic prices in recent months. (See Volume VI) 101- The depreciation would have been even smaller if the Bank of Korea had not increased its net holdings of foreign assets by $70.5 million behtwjn Mnrnbh and n-!cebnbr 1965. Annarently the Bank of Korea has kept exchange certificates in fairly short supply and thus influenced the exchange - 36 - rate, at least sli&-vtlth , *n fin r- of export. 1/ The altr to the improvement in the net foreign assets position of the Bank of' Korea would have been(i a -1-iqn" exhm rate - h w.T JLl have cmnnt- less exrni, imported inputs and a weaker incentive to export or (ii) the same exchange rat-e bumt- a ;great-er deg36e o-f 4trade 14ber ':zatior. I' -wo 'd be h-ardt argue, however, that the Bank of Korea in its action to improve its foreign assets position has-10 ------u rdi cnevtiep'c. ,, etfr.g .iL.OU._LVWVL,LL ħU .UJL"UUJy UULAui .L_V11L.LVe; JU..L_Lk..Y* .LUet I.L.VL ħU~.L; -J-6,L assets position of the Bank of Korea in March 1965 was negative and im- provemen-t- was obioisyneeser. G'othing imports shrunk in size to negligible proportions and foreign exchange outlays on other consumer goods did not increase. 1114. The mainn instruments of industrial policy during the past decade were import prohibitions combined with long-term credit facilities at preferentiall inte.rest rates and tax exemlptir.s. MI xh^er+ prlt ently undervalued the dollar and tariff duties, on the whole, were moderate in manltue. Ioweve, th lis of polliiteditem was ext-ensire ard L.LL. 1i~1LO6 -LULLU * IIVVVUVVJ.L, UL4ħ -LLOU lo .L Y .JL"LUJ. LjtZ J.1U~1I WO A _I0L V u~ covered nearly ever;y important item likely to encounter foreign competition. 1 / In,,l'Z I' -I / 1 1/ A-verage 195)6-57 Lo Average 1963-65 2/ See Volume V. 4 2 - - - ~ ~ ~ j-~~r,~ ~~~m" Ti A n VtnIT rVt T-.rTnrDm CITTDCYnTmITmT(TTrJ Taboie 'I ~ rU,-)L IUI'j Ur JI'IrU,rutJ I-iu ini rA1ħ1.auILLN ',Jħ ħLJU %Jit,L Luħ L. LLWLL A. Compositioni ofLvi ot Average 1956/5f Average 163/6 Amount Amnount Catego~~~~~~~ Million $5 PercenTi Mili ion $p Perceni Consumner Goods 94 23 809 19 Cereals 58 14 72) 15 Othear Food 18 410 2 Other 18 4~ 7 2. Intermnediate Goods 209 51 255 __5 Crude Materials 77 19 i1l 24 Manafactured Intermediates 132 32 144h 31 Manufactu-red Investment Goods 69 17 119 26 Unclassified 40 10 1 -- TOT;Vu Ivi{PORTS )414 100 465 100 B hr n? j~c~ rnnnr+.q j n +.ntnI sunnI v(O Average ħy956'57 A-verage 19)631u65 M4anufactured intermediates 38n 16 Chiemicals /1 34 49 Pa-per 32 3 Textiles 12 7 Rubber Manufacturing 9 0 Wood, F-ur-niture 2 0 IM'anufactured Investment Goods 42 33 Transport Equipmnent 26 27 Electrical Machinery 82 44 Other Machinery 50 57 Metal Products 11 18 Basic Metals 63 36 Non-Metallic Minerals 31 4 /1 Includes fertilizer. For notes and sources, see Volume V. - 143 - flonse+.1e . h nyrnf-xe-M vth iim1-r 1blln over V r Tnn Tnnnfiictn r ngi wa mnre or less impenetrablia and prices for major industrial products were consid- erablyr alhmrvrths in J+hcnn. r Irv' UT.qn For .pnn in Ooi f-.+nr Q'r 1Q5 the differential between Korean and international prices was as follows: - r'- -nn VA nrs+1 / e + --' h,- -2 Ln- - - - 1 -- / nn,nr n4 1 ncn"on+ 9/ '.'. .itMJJJ ^. ħaq 36' perce.t '/,S1 .1 aeeU~.l. bsa. .4 percerfU .I.t y, newsprintJf 31S pecn J- '. ammonium sulphate 12 percent 1/ and cement 18 percent. l/ These high prices may have meant high poi - c e---n4 pas u the whole the feeling of the Mission is that a comparatively high cost s t,ruc t --e tse LZ UII IIZLI nte _PlCUaIU-Vlo. 1ii. ħi1le -oreuan uovex'inri- en' lsax-e of -e high cosi pUre 'ucturuħ of doinestic manufacturing and is taking measures to improve the compet- itiveness of local firms. in l964, a step towards the liberalzation of' quantitative restrictions was taken. Presently 77 percent of imports financed by export earnings are not subject to quantitative restrictions but the list of prohibited items remains long. The Governmernt should consider a phased program of decontrol. A sudden removal of physical barriers may cause excessive dislocation. Domestic industry needs time to rationalize management and cut costs. Quantitative restrictions should be replaced by protective tariffs in the first instance and there should be a schedule for lowering tariffs in graduated steps over a period of time. 1/ 'he comparison is with Japan. 2/ The cornparison is with USA. -. ha - TI, rrETMmA Tr'ZTv =AlJroT' OT. F THE SE MUT OTM WTNrP_m V-TEAR PT.k V T riml ħr11J_AI. _i~ħV:# Ul WtII,~'ii, 'J~ ħħ1 A. The Nature of the Planning Process 116. Generally speaking, the Mission was impressed by the enthusiasm, ambition, and sophistication of Korean planners. Unlike other planning agencies, the Economic Planning Board in Korea is not divorced from other Government Agenc-es and a beginning has recently been made in seeking the collaboration of the private sector. There is widespread awareness of plan targets inside and outside the Government. Korean planners are receiving considerable technical assistance from abroad in the formulat-ion of the Second Plan, which will begin in January 1967. Hopefully the Second Plan, scheduled to be ready in July 1966, will turn out to be a well-considered, operational document which provides valuable guidance to government agencies and private parties in Korea as well as to members of a Consultative Group,if one is organized, and potential foreign investors. 117. Readers f'amiliar with the most recent developments in Korea may find that the Mission's observations are somewhat dated. Probably, many thines have changed! in Seoul since the Mission's visit towards the end cf 1965. At that time! Korean planners were working at three levels of analy-sis: (a) the project-program level, (b) the sectoral level, and (c) the level of macro-economic magnitudes. 118. Work at the level of specific projects and programs seemed to be lanquishing at the end off 196q. In March 1965, the Economic Planning Board (EPB) requested ministries and other government agencies to submit proposals regarding potenntal investments during the Second Plan. In turn, the iMlinistry of Commerce and Industry sought the cooperation of various trade and industrial associtions in the rivate sector. Many useful studies were prepared in response to this request. However, the data assembledid not lend itsel;-' to a systematic screening of prolects. Frequently, the iniformation was unreliable or incomplete. Work is now under way to overcome. these shortcanings and prepare a revised list of projects for inclusion in the Second Plan. 119. At the sectoral level, there is more sophistication. Korean piannrers axe cuLce.Ltvrating on luiVe implemer.tatio of a l3 sector Jintr- industry model based on the 1963 Input-Output Table. Work is under way to assess present industrial capacity, to establish investment coeffi- cients based on past data and to project private consumption, public consumption as well as exports by- sectvor. Altogether, this work represents an ambitious application of formal planning techniques which may prove to be valuable, provided several formLdable data problems can be solved. In this connection, technical assistance is being furnished by the 11.S. Operations; Mission, the lMathan Advisory Group and the German Advisory Group. - 45 - 120. Inp+-Ioutpu+ sa ysisrA has a y p d uefu N rl it yi.elded valuable information concerning the present structure of the econcI