Macroeconomics from Korea Inc to Market Liberalization

From General Park's establishment of wide- ranging economic reform in 1963 until 1997, real per capita income growth averaged above 6 per cent annually in Korea. Undoubtedly, the Korean miracle rested on a particular mix of market incentives and state direction, together with a highly repressed financial market where domestic savings (plus international aid) financed capital accumulation. Industrial policy guided financial system behaviour, with (national) banks directing funds to the productive sector.

As occurred in many Asian countries, after a brief experiment with flexible exchange rates, the Korean won was formally pegged to the dollar, and it would remain that way until 1980, when a currency basket replaced the peg (although it remained centred on the US dollar). Likewise, international capital flows were highly controlled and financial repression widely extended. Controls were present in several sectors, and strict restrictions were imposed on FDI if not directly banning it. Similarly, outward FDI required prior official approval to go ahead. Trade policy was also under government scrutiny, which was particularly vigilant on the import side of the balance. The local currency was nonconvertible and, as experienced by other developing countries at the time, the Korean government also discouraged any offshore market in won or won- denominated instruments. The current account was also firmly controlled and strict exchange restrictions were applied to all capital outflows until the 1980s.

When General Chun came to power, in 1979, liberalization began to gain momentum (Nolan, 2005), although liberal policies were timid and not extensively implemented (Cho, 2010). Thereafter, interest rates began to be determined on the market, marking the beginning of the end of the financial repression era – although the government maintained de facto control over the same rates. A similar erratic liberalization was observed with the new ER determination scheme, as authorities did not leave the currency to freely move. At the same time, the government also promoted the emergence of a powerful shadow- banking sector. Finally, and despite all these (timid) liberalization efforts, Korea's financial markets remained closed to foreigners.

Further liberalization measures were adopted in the mid- 1990s, and were particularly aimed at opening the local financial sector to the outside world. The Kim Young- Sam government resumed the reform process, further liberalizing both ER and money markets.