Why a free market explanation for South Korea’s growth does not stand up to scrutiny

Didn't fit into my dissertation, but interesting nevertheless. It's not exactly controversial to argue that free-market explanations are not the place to look to explain South East Asia's growth-experience, but I found it interesting to actually sit down and try to argue why.

One explanation for South East Asia growth focuses on the provision of a good investment climate without excessive distortions in the economy. East Asian growth arose thanks to reliance on private markets (Friedman and Friedman 1980, quoted in Wade 1990,22) and the government simply provided “a suitable environment for the entrepreneurs to perform their functions” (Chen 1979 in Wade 1990,22). Government intervention that did occur is presented as neither sufficient nor necessary, with the key role pertaining to “fundamentally sound, market-oriented policies” where “market forces and competitive pressures guided resources into activities that were consistent with comparative advantage” (World Bank 1993, 325). Most neoclassically inclined commentators do give the government a decisive role, however, where the importance of promoting export through maintaining a neutral exchange rate is acknowledged (Bhagwati 1988 in Wade 1990,22).

Evidence from South Korea does not seem to strongly support this proposition. For this mechanism alone to account for growth, financial capital must be readily available and the prevailing prices must make productivity-enhancing investments appear profitable [incentive] while competition must be so high that failing to do so will mean that the economic agent rapidly will loose business and risk bankruptcy [compulsions]. This does not seem to have been the case. First, foreign investment was restricted by the government and domestic capital not arising from the firms’ own savings was not available to any project which would be likely to repay its debts, but rather provided through politically determined cheap credit which was deployed by the government according to their preferences (Amsden 1992). Second, competition in many sectors was low and actually restricted by the government which assisted in establishing huge conglomerates, promoted mergers and directed entry and exit of firms, leading Korea to have one of the highest market concentrations in the world (Sing 1995, 27) and at best having an oligopolistic competition of the giants (ibid. 30). Finally, high investment, together with high human capital, was the key component of Korea’s growth (Young 1995, Krugman 1994), and although a neutral exchange rate and other export promoting policies made exports relatively more profitable at times , exports in 1960 accounted for only 5 percent of GDP, so even large export-related investments could not account for raising the investment share of the economy as a whole from 10 percent of GDP in 1960 to 25 percent in 1970 (Rodrik 1995, 68). In sum, many of the incentives and compulsions arising from prices did not reflect scarcities through a free market system and the neutral exchange rate may not have had a large enough effect to account for the shift to high growth.

Sources:

Amsden, Alice. 1992. A Theory of Government Intervention in Late Industrialization. In Louis Putterman and Dietrich Rueschemayer (Eds) State and Market in Development. Synergy or Rivalry?, 53-84. Boulder & London: Lynne Rienner Publishers.

Krugman, Paul. 1994. The Myth of Asia's Miracle. Foreign Affairs 73, no. 6.

Rodrik, Dani. 1995. Getting interventions right: how South Korea and Taiwan grew rich. Economic Policy 10, no. 20: 53-107.

Sing, Ajit. 1995. How did East Asia grow so fast? Slow Progress Towards an Analytical Consensus. UNCTAD Discussion Paper No. 97.

Wade, Robert H. 1990. Governing the Market: Economic Theory and the Role of Government in East Asian Industrialization. Princeton, NJ: Princeton University Press.

Young, Alvin. 1995. The tyrrany of numbers: Confronting the Statistical Realities of the East Asian Growth Experience. The Quarterly Journal of Economics 110:641-80.