domestic credit was favourably allocated to the industry/' The industry has also maintained a very high ratio of foreign loans to value added relative to other manufacturing sectors, which means that capital investment in the industry has depended more on foreign sources than on domestic credit. Accessibility by an industry to foreign loans is, however, not especially relevant to the issue of domestic credit rationing. Such high LV ratios of foreign loans in the industry are largely due to the industry's, and in particular POSCO's, successful foreign loan negotiations in the mid and late-1970s when successful operation of the industry attracted low interest foreign investment and when there was strong lending competition among foreign fund suppliers. The industry also received priority in relation to general foreign loans procured by the govemment from international financial institutions such as the Asian Development Bank and the World Bank.
The high ratios of LK or of LV in the iron and steel industry may not by themselves imply that the industry has received relatively favourable treatment with respect to loan allocations. The very nature of the industry, which is relatively more intensive in using physical capital, means it requires a high ratio. However, given the subsidised nature of loans due to interest restraint, a ratio in a sector above the manufacturing average implies that the sector receives a relatively large subsidy allocation per unit of capital or per value added (Hong and Park, 1986, p. 168). It should also be noted that, among domestic loans, there were differences in interest rates on different types of loans (Table 6.4). It may be the case that, if a sector was designated as a high priority, it could be allocated relatively more policy funds through interest rates that were lower than other bank loans. In this case, the relative size of the interest subsidy received by the industry could be larger than the LKor LV ratios imply. In the case of iron and steel, the relative magnitude of the interest subsidy on long-term domestic bank loans could be higher than the figures (L), since the industry was known to be one of the major recipients of loans from the National Investment Fund and other policy funds. Nevertheless, the figures in Table 6.5 alone do not clearly indicate the
14. The major export-oriented industry, classified as 'textiles, etc." in Table 6.5, shows that, in the 1970s, the industr>' was able to access more credit than the manufacturing average, in particular short-term bank loans such as short-term expon credit. However, a specific conclusion of credit rationing in relation to the heavy and chemical industry drive is hard to draw from the figures of very aggregated sector classification at the 2-digit ISIC level. The only two classified at the 3-digit level in the table are iron and steel (371) and non-ferrous metals (372). Using a detailed industry classification, Hong and Park (1986) show that, among the heavy and chemical sectors, basic metals, industrial chemicals, cement, automobiles and parts, large machinery firms and shipbuilding are major sectors having clearly higher ratios than the manufacturing average in the 1970s and early 1980s. Miscellaneous chemicals, electronic and telecommunication equipment, electrical machinery and medium and small-size machinery fums shows ratios of less than one during the period. Among the light industry sectors, the ratios for textiles, wood products and synthetic fibres were larger than one, while those for clothing and footwear were less th^ one.
relative magnitude of the interest subsidies implied by credit rationing with interest rate restraint.
The interest subsidy rate can theoretically be defined as the difference between an undistorted equilibrium interest rate in given credit supply/demand conditions and an actual interest rate set below the equilibrium rate. However, since the only data available to this study are the controlled actual rates vaiying across different loan types, it is impossible to calculate the exact subsidy rates. Instead, this study calculates
MGi = RKi - ICi,
where MGi is the margin between RKi and ICi, used as a proxy for the rate of credit subsidy received by the industry i; RKi is the estimated rate of return on total capital; and ICi is the estimated real rate of average interest costs on total loans.
This method is basically drawn from Hong (1981, 1990) and Hong and Park (1986). The estimated rate of average interest costs is defined as the ratio of total outstanding interest payments to total loans from both domestic and foreign sources. Hong (1981, 1990) and Hong and Park (1986) used, instead of IC, the weighted average real interest rate on domestic loans. Using their terms, the same interest rates can be applied to all firms or industries in estimating interest subsidy rates. Using IC, different interest rates can be applied to different firms or industries, which seems more realistic. With tiie limited data, however, IC cannot exclude interest costs on foreign loans, most of which were not affected by the government control over credit allocation and interest rate ceilings. Nevertheless, they are affected by various financial policy measures such as exchange rate policy or other monetary policies that change the real rates. The use of IC then can reflect, given the rate of return on capital, the overall effects of financial policies on interest subsidy rates. In the case of the estimated average rate of return on capital, this study uses the same definition as in Hong (1981, 1990) and Hong and Park (1986), namely the ratio of the non-labour share of value added to total capital stock consisting of physical assets and net working capital. By allowing positive net profits in value added, some positive MG can be expected even if there is no interest subsidy. Given the interest rate ceilings in the Korean economy of the 1970s and 1980s, a pan, though not all, of the MG can be attributed to interest subsidy rates.'^
The ratios of sectoral MG to the manufacturing average {mg) rather than the absolute values of MG are illustrated in Table 6.6, and can be interpreted as each sector's relative interest subsidy rates. An industry's mg of greater than one implies
15. When positive MG is calculated, this cannot all be attributed to the subsidised credit rationing. For example, a part of the estimated rate of return on capital may in fact come from wage resu-aint in the Korean economy in the 1970s. On the other hand, at given interest rates and wage rates, a firm or industry with better business performance will reveal a higher return on capital.
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Table 6.6 Relative interest subsidy rates and capital intensity in Korea, selected industries, 1971-89 (ratios to total manufacturing average)
Manufacturing total Textiles, etc. Chemicals, etc.
ICN IC RK MG K/L ic rk mg k/l ic rk mg k/l 1971 13.4 -0.6 11.2 11.7 3.77 -1.2 0.9 1.0 0.7 -2.9 1.1 1.4 1.5 1972 12.0 •A.7 13.7 18.4 3.83 -1.0 1.0 1.4 0.8 -1.7 1.0 1.5 1.4 1973 8.5 -5.1 16.1 21.1 4.29 0.2 0.9 1.2 0.7 0.7 1.0 1.3 1.5 1974 10.5 -20.0 13.7 33.7 5.15 -1.5 0.8 2.4 0.7 2.7 1.1 2.4 14 1975 11.3 -13.9 14.3 28.3 6.07 -1.0 0.8 1.9 0.9 1.8 1.2 2.1 1.3 1976 11.9 -9.3 15.3 24.6 7.19 0.3 0.9 1.5 0.9 1.4 1.2 1.7 1.1 1977 13.1 -3.5 14.7 18.3 8.38 0.5 0.8 1.0 0.8 -0.8 1.0 1.3 1.1 1978 12.4 10.4 15.0 25.4 9.01 3.1 1.0 1.5 0.7 2.9 1.2 1.7 1.3 1979 14.8 -4.8 15.5 20.3 11.33 1.2 0.9 1.2 0.7 2.5 1.2 1.3 1.4 1980 18.7 -5.3 12.9 18.2 16.02 0.2 1.0 1.4 0.7 4.9 1.3 1.3 1.3 1981 184 1.4 13.5 12.1 20.93 0.4 1.1 1.0 0.7 2.5 1.1 0.8 14 1982 16.0 84 12.9 4.5 24.19 0.0 0.9 0.3 0.6 2.2 1.1 0.3 1.4 1983 13.6 9.1 13.5 4.4 26.35 0.9 0.9 0.2 0.6 0.3 1.1 0.4 1984 14.4 10.5 13.4 2.9 28.60 -0.3 0.9 0.1 0.6 3.0 1.2 0.2 1985 13.4 9.3 13.4 4.1 31.73 0.6 1.0 0.2 0.6 0.5 1.2 0.4 1986 12.5 9.7 14.3 4.6 34.57 0.2 1.1 0.4 0.6 0.5 1.2 0.4 1987 12.5 9.0 14.8 5.8 39.43 0.1 1.2 0.6 0.5 0.4 1.1 0.4 1.7 1988 13.0 7.0 15.4 8.3 45.22 -0.6 1.0 0.6 0.5 -0.5 1.0 0.6 1.7 1989 13.6 8.4 14.3 5.9 56.21 -0.9 0.9 0.4 0.6 -1.2 1.0 0.5 1.7
Iron and steel Non-ferrous metals Machinery, etc.
ic rk mg k/l ic rk mg k/l ic rk mg kJl 1971 -2.4 0.6 0.8 1.6 3.2 0.9 0.7 0.9 6.9 1.1 0.6 0.8 1972 -0.2 0.5 0.8 1.7 -4.1 0.5 1.2 1.7 2.6 0.8 1.0 0.8 1973 -2.6 0.8 1.2 3.1 2.6 0.7 0.8 1.4 0.1 1.0 1.3 0.7 1974 -2.6 1.1 2.7 3.3 -1.5 0.7 2.3 1.8 1.6 1.0 2.4 0.7 1975 -3.5 0.7 1.9 3.1 0.5 0.8 1.8 1.5 -0.7 1.0 2.0 0.6 1976 -4.1 0.6 1.5 3.2 -4.9 0.9 1.9 1.8 -0.3 1.0 1.6 0.7 1977 -1.4 0.9 1.3 3.6 -0.2 1.0 1.3 1.4 0.2 1.1 1.3 0.8 1978 -5.8 0.7 1.8 3.8 -1.9 1.7 2.5 1.0 -0.9 0.8 1.5 0.9 1979 -5.2 0.9 1.5 3.5 -1.1 1.0 1.3 1.1 -1.4 0.7 1.1 0.9 1980 -7.3 0.9 1.9 3.5 2.2 1.0 1.2 1.1 1.0 0.7 1.1 0.9 1981 -3.4 1.1 1.2 2.7 0.9 0.8 0.6 1.5 -0.9 0.0 0.8 0.8 1982 -4.7 1.0 0.7 2.8 -1.8 0.8 0.2 1.6 -0.3 0.9 0.3 0.9 1983 -3.1 0.9 0.5 3.0 1.8 0.9 0.1 14 -0.6 1.0 0.3 0.9 1984 -2.0 1.1 0.5 2.6 -2.7 0.8 0.2 1.4 -0.4 0.9 0.1 1.0 1985 -3.0 1.1 0.6 24 •3.3 0.7 0.3 1.4 -0.2 0.9 0.1 1.0 1986 -3.8 1.0 0.6 2.4 -2.4 1.0 04 1.3 0.1 0.9 0.2 1.0 1987 -3.0 1.2 0.8 2.6 0.0 1.2 0.6 1.2 0.2 0.8 0.2 1.0 1988 -3.8 1.3 1.0 2.6 0.3 1.3 0.8 1.2 0.8 0.8 0.3 1.0 1989 -3.3 1.3 1.0 2.9 -0.3 0.9 04 1.2 1.2 0.9 0.3 1.0
Notes ICN rate of interest costs at current prices (per cent)
IC real rate of interest costs = ICN - inflation rate (per cent) RK return on total capital (per cent)
M G differences between RK and IC
K/L capital intensity at current prices (million won)
ic differences between the sector's IC and the manufacturing average
rk ratios of the sector's RK to the manufacturing average
mg ratios of the sector's MG to the manufacturing average
kJl ratios of the sector's K/L to the manufacturing average
that the industry was, relative to the manufacturing average, favourably subsidised through credit rationing and restraints on interest rates. Although manufacturing's average rates of return on capital have been rather stable, the estimated credit subsidy rates (MG) in the 1970s and the early 1980s were very high compared to those in the rest of the 1980s (Table 6.6). While govemment control over interest rates continued until the late 1980s, the higher MG in the 1970s was due particularly to the government's expansionary monetary policy in this period, which maintained inflation rates high enough to make real interest rates negative. The high inflation rates affected not only real interest rates on domestic loans but also those on foreign loans. Thus, an industry's accessibility to foreign loans, where in general lower interest rates than those on domestic loans were applied, is also related to allocation of interest subsidy, though not especially relevant to credit rationing. According to calculations by Hong (1990), the weighted average real interest rate on foreign loans was about 2.1 per cent per annum during 1967-71 and -7.4 per cent during 1972-76. In the 1977-81 period, the London Inter Bank Offered Rate (LIBOR) for the Eurodollar was about 13.2 per cent per annum on average. Taking into account depreciation of the domestic currency (won) at an average of 7 per cent per annum and an approximately 19.5 per cent inflation rate in the period, it is possible that the average real interest rate of foreign loans did not exceed 1 per cent per annum.
Negative real rates of interest costs in this period were realised by most manufacturing sectors. Among them, the iron and steel industry in particular has enjoyed very low rates of interest costs compared to the manufacturing average (Table 6.6). Even though significant variations in the rates of interest costs and the rates of interest subsidy might be observed when the industry classified at the 2-digit level is disaggregated into more specific sectors, there has been no attempt here to examine the other specific sectors in the heavy and chemical industry. The rates paid by the industry, not only during the heavy and chemical industry drive period but also until recent times, averaged 3.5 per cent per annum below the total manufacturing average rates. The important sources of such low interest costs were the industry's priority access to low interest policy funds and, as implied by the figures in Table 6.5, a particularly high ratio of foreign loans to value added compared with other sectors.
Owing to the very low rates of real interest costs, the iron and steel industry during the heavy and chemical industry period was also able to maintain relatively high rates of the estimated credit subsidy {mg > 1), regardless of the relatively low rates of return on capital below the manufacturing average {rk < 1). This led to enormous capital expansion in the industry. The iron and steel industry's capital intensity before the formal implementation of the heavy and chemical industry was at a similar level to
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the chemical industry average, and the relative intensity to the manufacturing average i m was slightly above 1.5 (Table 6.6). The it//ratio sharply jumped to 3.1 in 1973, which made the industry one of the most capital-intensive sectors in Korea. From that time until 1980, the industry maintained kll at a level between 3.1 and 3.8. One important implication of the low rk but high mg above the manufacturing average is that the substantial expansion of the industry in capital intensity, and hence in output and exports in the 1970s and early 1980s, may be due to some extent to the subsidy element associated with credit rationing.
The relatively low rates of return on capital began to exceed the manufacturing average and have improved since 1981. In contrast, credit subsidy dropped to a level below the manufacturing average in the mid-1980s and, recendy, have been maintained at the manufacturing average. The steel industry's k/l ratio also dropped a little and then maintained a level of around 2.5. This happened despite the still relatively low real rates of interest costs and relatively high ratios of foreign loans to value added (Table 6.5). This trend may imply that, beginning in the early 1980s, favourable treatment for the iron and steel industry through subsidised credit rationing was removed as the industry was seen to have moved out of the infant industry stage and to have become more competitive in both domestic and international markets.