Capital market intervention by the Korean government resulted in a high degree of financial repression and overall inefficiency and misallocation of national resources (see Kwack, 1984; Park, 1986; Kim, 1990; Nam, 1990; and Yoo, 1990). The cumulative effect of the capital market distortions has increased with the transition of the economy to a more mature stage of development where allocation criteria are relatively more complex and difficult to devise.
Even at the selected industry level the effect of credit rationing and interest rate restraint on capital investment does not seem to have always been desirable. Looking at the Korean heavy and chemical industry as a whole, we can observe two major problems resulting from discriminatory credit rationing. One is the problem of excessive capacity leading to low capacity utilisation and inefficient performance. The other is the credit diversion problem (Hong, 1990; and Hong and Park, 1986).
21. It has an important implication for industrial growth whether the industrial policy is oriented toward import substitution or export promotion. It has been argued that provision of unbiased incentives for suppl>ing both domestic and international markets implies a greater potential for competition with foreign producers and will bring about more efficient resource allocation and greater efforts by firms to boost their competitiveness. See Appendix 5 for a brief review of the literature concerning the effects of import substimtion and export promotion strategies.
22. An important point in the Korea's export promotion strategy is that export incentives varied little among commodities or industries, so tiiat exports at excessive costs were discouraged and the composition of exports were allowed to evolve according to Korea's comparative advantage structure OVestphal and Kim, 1977; and Young, 1986).
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The prevalence of subsidised credit rationing accelerated substantial capital deepening in many of Korea's manufacturing sectors.^ As Hong (1981, 1990) points out, excessive capital deepening existed in many sectors, beyond the level that can be justified by a shift in the basic comparative advantage position or by the dynamic infant industry arguments, the chemical industry being a typical example. Large excess capacity and poor production and export performance in the industry, in the presence of low domestic demand and worldwide excess capacity, greatly burdened the national economy in the early 1980s.
The prevailing judgement was that the investment drive through credit rationing and interest restraint was a poor idea, especially in the early 1980s when the second oil shock hun the nation's heavy and chemical sectors. As discussed in Dombusch and Park (1987), however, the investment drive ultimately contributed to achieving international competitiveness in many of the industries by giving them the opportunity to expand capacity above the minimum efficient scale, to import advanced foreign technology and to gain an export market share. The iron and steel industry along with the automobile industry are cases in point. In any event, the investment portfolios in those industries seemed sufficiendy well chosen that real wages increased and exports expanded enough to pay interest and even principal on the external funds that helped finance the investment (Dombusch and Park, 1987).
There had also been a diversion of a large part of credit to the uses of real resources other than those designated by the government. This may be one of the factors which limited the effectiveness of government policy or further distorted allocation of physical resources. The study by Hong and Park (1986), though tentative, suggests a high degree of credit fungibility in Korea's manufacturing during the 1969- 81 period. According to them, the heavy and chemical sectors, where the bortowers were usually large industrial groups, are in general characterised by a relatively high degree of credit diversion, but the iron and steel industry showed a very low degree of credit diversion relative to other sectors and achieved relatively high efficiency and export performance during the heavy and chemical industry drive period. Possible explanations for that, as Hong and Park suggested, are that the industry was the major recipient of Korea Development Bank loans and foreign loans, the usage of which was strictiy controlled and supervised by the bank and the government, and that much of the investment in this sector was undertaken by POSCO, which won international renown not only by vigorous commitment to business success but also by prominent leadership and the hard work of its management (Innace and Dress, 1992).
23. Magee (1976) argues, in his two by two model, that too many subsidies on the use of capital in the capital-intensive sector will raise, in addition to wage rates, capital intensities in both the capital- intensive and the labour-intensive sectors.
The government's financial policies, especially in the 1970s, can be considered to have created two strong incentives for the development of steel and other strategic industries. First, firms were stimulated to invest since low interest rates and access to bank loans served to increase the expected rate of return on, and reduce the cost of, their investment. Second, the perceived risk of investment was reduced as the government assured a stable flow of bank loans to the firms regardless of their short- term financial performance. In other words, the government, by controlling the financial sector, became a risk partner for the firms, encouraging them to undertake projects that otherwise might have declined. Other promotional and protective policies also provided the Korean steel industry with incentives to invest and export and helped it enhance industrial competence. Even though these incentives caused problems of excessive investment and credit fungibility in some firms or industries, the steel industry was able to avoid these and achieve rapid growth and high efficiency. However, these facts alone do not necessarily imply that financial policy for the steel industry was effective. In fact, the effects of industrial policies at a selected industry level are complicated and difficult to evaluate, since policy measures always involve economic costs and benefits.^ Costs and benefits generated by a specific industry are even more difficult to measure, because the government's financial policy and some other important measures were applied generally to all heavy and chemical industries, on the one hand, and the assistance given to the industry would have generated complicated externalities, on the other. For example, even though a study by Research Centre for Social Science (1987) shows that the establishment of POSCO has consequently contributed enormously to the national economy, measurement of the effects of policy on POSCO's growth is complicated by the costs incurted by the national economy as a whole.
PRR'ATISATION OF POSCO AND T H E LIBERALISATION PROCESS
In the early 1980s, as the Korean steel industry grew and enhanced its competitiveness both in the domestic and the international markets, internal and external pressure began to increase not only for liberalisation but also for privatisation of POSCO. Internal
24. Since the intent of industrial policies typically extends beyond the aims of the industrial business enterprise, the criteria on which industrial policy must be judged are considerably broader than those applying to the success of business investment (Adams, 1985). Thus, it is not sufficient to ask whether an industry that has been promoted by industrial policy is earning a competitive return on its invested capital. The success of an incentive favouring one sectOT over others needs to be evaluated on the basis of other criteria with respect to all other industries and the economy as a whole, such as impact on emplo>Tnent, trade balance, production costs, technological development, industrial structure and externalities. However, not all these considerations are readily measurable. Even if the measurement is possible, it is not always clear whether benefits exceed costs, or vice versa.
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