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Korea's Economic Success: Strategies,Challenges, and Lessons for MongoliaChoongsoo Kim

GovernorThe Bank of Korea

August 15, 2011

0ContentsIntroduction

Korea's Economic Development

Overcoming Financial Crises: Korea's Choice

G20 Korea Initiatives

1Implications for Mongolia of Koreas Success 1 Snapshot of Koreas Success Purposes of Todays Lecture 2Introduction

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3Modernization (1): Past vs PresentThe same place, 60 years apartGangnam circa 1950sGangnam 20103

4Modernization (2): Past vs PresentThe same place, 60 years apartCheonggyecheon circa 1950sCheonggyecheon 20104

5Industrialization: from low-tech to high-techTypical apparel factory circa 1960s Electronics factory 20105

6Bumpy Road but Steady Course to DemocracyProtest against despotcirca 1980sAdvanced to democracyPresent6

7Financial crises: 1997 vs 2008

1997 crisis2008 global crisis

78Per capita Income: US$ 82 (1961) US$ 20,759 (2010)

Size of GDP: US$ 2.1 bil. (1961) over US$ 1 trillion (2010)

Joined the OECD (1996)

Joined the OECDs Development Assistance Committee (2009)

Hosted the G20 Summit (2010)Development Outcomes

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9Sustained Growth but not without DifficultiesGDP growth rate (quarterly, YoY)

2nd Oil Shock1997 Crisis2008 Crisis9

Quick Recovery from the Global Financial Crisis10GDP growth rate (quarterly, YoY) (%)Korea (t=1997 Q4)Korea (t=2008 Q3)10Purposes of Todays LectureTo share Koreas experiences in economic development and crisis management

To explain how such experiences were reflected in Korea Initiatives at G20 meetings of 2010To draw implications for Mongolia of Koreas economic development model11

11Brief Historical OverviewContributing Factors to Korea's Economic Success12

Korea's Economic Development

12Post-war reconstruction: 1945 through 1950s13Development Goals: Curbing hyper-inflation (peaked in 1951 at over 390%)Postwar reconstructionRestoring political and social stability

Targeting import substitution cum fiscal austerityForeign aid-dependent economic management Limited tangible outcomes with only moderate economic growth (Average annual growth rate was 3.8% during 1953-1960)

13Switch in economic development strategy

Key rationales:Need to resolve the balance of payments problems following reduced foreign aid Import substitution for non-durables almost completed Shortage of natural resources

Exports considered only as means to achieve economic development14

Import Substitution +Priority on StabilityExport-driven +Priority on GrowthExport-driven Industrialization: 1960s through 1970s14Export-driven Industrialization: 1960s through 1970s (continued) Five-Year Economic Development Plans (1st plan in 1962, six plans in total) Served as catalyst for economic miracle

Blueprint of government-led resource allocation in the absence of well-functioning markets

Helped improve policy continuity and flexibility over a long horizon15

15Economic Stabilization and Liberalization: 1980s through Mid 1990sSwift transition in economic development strategy to address growing macroeconomic imbalance

High inflation rate (CPI 29%, PPI 39% in 1980)

Burgeoning fiscal deficit: 1.4% of GDP in 1979 4.5% in 1981

Worsening CA deficit: 2% of GDP in 1978 8.3% in 1980

From state-led planning to indicative planning

Government: strategic vision

Private sector: specific actions16

Government-led +Growth Promotion Private Sector-driven +Stability Enhancement16Economic Stabilization and Liberalization: 1980s through Mid 1990s (continued)Stabilization Policies:

Monetary and fiscal tightening (cold turkey)

Domestic deregulation

Trade liberalization

Income policy (e.g., forward looking wage contracts)

Policy credibility earned by delivery of targeted outcomes

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Outcomes:

Inflation rate (CPI): 29% in 1980 2.3% in 1984Fiscal balance: -4.3% of GDP in 1981 +0.2% in 1987

CA balance: -8.3% of GDP in 1980 +4.1% in 198618Economic Stabilization and Liberalization: 1980s through Mid 1990s (continued)Current account balance, Fiscal balance

Inflation18Albeit successful stabilization, vulnerability to external shocks remained

Heavy reliance on external demand

(export + equipment investment)/GDP ratio: 32.1% in 70s 42.5% in 80s 36.2% during 1990-96

Debt-ridden corporate sector

Debt-to-equity ratio: 336% in 1996

Increased exposure to foreign capital flows

Shortening of external debt maturity

Short-term debt-to-total external debt ratio: 50% in 1996

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Economic Stabilization and Liberalization: 1980s through Mid 1990s (concluded)19Financial Integration and Economic Reform: Late 1990s through Present Two financial crises

Witnessed danger of ill-prepared financial integration (1997 crisis)

Triggered comprehensive reform

1997 crisis

Rooted at domestic structural vulnerability

Followed by major restructuring and financial opening

2008 global crisis

Exogenous shock beyond domestic control

Revealed shortcomings of the current international monetary system

Korea Initiatives at G20 for global solution

Strengthening of macroprudential policies20

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21Outward-looking Development StrategyFlexible Adaptation of Economic Policies Emphasis on Market Principles

Contributing Factors to Korea's Economic Success 21Outward-looking Development Strategy22Reap the benefits of open economy:

Efficiently utilize changes in external environment

Strengthen competitiveness through global competition

Take advantage of economies of scale

Minimize government failure and prevent corruption by market

discipline (imported through exports)

But constantly exposed to external shocks and spill-over risks,both financial and real

Took challenges posed by the risks by pursuing further market opening and reform, in view of:

Those risks being manageable with prudent policiesMarket opening being the most effective way to upgrade the economy to an advanced level

22Outward-looking Development Strategy (continued)Korea signed FTAs with the EU and the US*. * waiting for ratificationSignificance:Show Koreas firm commitment to free trade Help fight against the specter of protectionism at this critical juncture Provide an exemplary case for cooperation between countries of large difference in size and development stage

2323Flexible Adaptation of Economic Policies 24Import substitution (1950s)Light industry orientation (1960s)Growth-acceleration/poverty reduction (1960s-70s)Financial suppression (1950s-70s)Government-led growth (1960s-70s)Capital account controls (1950s-80s)Export promotion (since the 1960s)Heavy and chemical industry orientation(1970s)Sustainable growth with durable stability(since the 1980s)Financial deregulation(since the 1980s)Private sector-led growth (since the 1980s, particularly after the 1997 crisis)Capital account liberalization (since the early 1990s) 24Emphasis on Market PrinciplesSteady transition from government-led to market-driven economy through liberalization

Upheld market principles even under government-led growth (e.g., indicative planning)

Strong will to economize interacted with tangible economic success

Entrepreneurship enabled firms to take risks for returns and lead technology development

Forward looking patience induced households to save and learn more for the future (Confucian ideology)

Government invested in education, and encouraged private investment through partial risk-sharing and tax incentives

2525Financial Crisis of 1997Global Financial Crisis of 2008

26Overcoming Financial Crises: Korea's Choice

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27Comparing the 1997 Crisis and the 2008 CrisisStock price, Interest rateExchange rate, Capital inflow*1997 Crisis2008 Crisis1997 Crisis2008 Crisis* Changes in liabilities including portfolio investment, financial derivatives and other investment27

28Comparing the 1997 Crisis and the 2008 CrisisCA/GDP, International reserves1997 Crisis2008 Crisis1997 Crisis2008 CrisisGDP growth rate(quarterly, YoY), Unemployment rate28Accumulated structural weakness Massive capital outflow Failures of big companies29 Contagion from Southeast Asian crisis IMF rescue package+Government-ledrestructuring< 1997 crisis > Ill-sequenced capital account liberalization

Heavy reliance on external debt

Inadequate foreign reserves

Denied rollover of short-term external debt

Collapse of investor confidenceUnprecented monetary tightening

Financial and coporate restructuring

Fiscal backing Overvalued FX rate

CA deficits

Debt-ridden corporate sector

Lax risk managementIncreased vulnerability to external shocks+Comparing the 1997 Crisis and the 2008 Crisis29DeleveragingFlight to qualityIMF support ?

No, not this time30Sufficientpolicy space< 2008 Global Crisis > Comparing the 1997 Crisis and the 2008 CrisisProcyclicality of capital flows

High trade linkage to advanced countries

Global imbalances

Housing bubble in advanced countries

Subprime crisis

Counter-cyclical macro policies

Flexible FX rates

Ample liquidity buffer + SWAP with the Fed

Capital outflowJittery financial marketCollapsingglobal demandExport Growth Quickrecovery+Macroprudential reformGrowth rebounded by 2009

Bank levy

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31G20Development Issue Global Financial Safety NetsG20 Korea Initiatives

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32G20 meetings

32Formed in 1999

G7 + 12 EMEs* + EU

* Argentina, Australia, Brazil, China, India, Indonesia, Korea, Mexico, Russia, Saudi Arabia, South Africa, Turkey

Account for 85% of world GDP

* share in world GDP

Emerged as a premier forum for global economic issues * First summit meeting in Nov. 2008 (ministerial meeting until 2007)

Basic Facts about the G2033Economic weight* of G7 and EMEs(%)3334Korea Initiatives at the G20Development IssueGlobal Financial Safety Nets

34Korea Initiatives at the G2035Focus on shared growth for all countries

Seoul Development Consensus for Shared Growth helps developing countries increase their capacity rather than providing more financial aid.

* Korea has been running Knowledge Sharing Program since 2004

Discussing Development Issue helps strengthen legitimacy of G20. Development Issue

35Korea Initiatives: Global Financial Safety Nets (GFSNs)36Global crisis reveals a number of shortcomings in the international monetary system including:

Absence or malfunctioning of international adjustment mechanism to correct global imbalances

Under-regulated capital flows often resulting in booms & busts

Heightened volatility in major exchange rates

Financial interconnectedness amplified and propagated shocks quickly around globe to affect innocent bystanders

Not only emerging but also advanced economies need financial safety nets

GFSNs should be more efficient than self-insurance (i.e., risk-pooling)

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37Korea Initiatives: GFSNs (continued)Exchange rate Volatility

Volatility jumped in times of crisisEver-increasing self-insurance?Foreign Reserves/GDP(%)37Enhanced liquidity provision by the IMF (Flexible Credit Line + Precautionary Credit Line)

Need to construct a multi-layered network for certain, sufficient, stigma-free liquidity support while minimizing moral hazard

Global level: IMF assistanceRegional level: regional financing arrangementsBilateral level: swap lines between central banks

To be pursued along with other G20 agendas (e.g., reducing global imbalances, financial regulatory reform)38Progress made Korea Initiatives: GFSNs (concluded)Going forward

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39Implications for Mongolia of Koreas Success

VMy Understanding of the Mongolian EconomyImplications of Koreas Success39

40Close Ties between Mongolia and Korea

MongoliaKorea

40My Understanding of the Mongolian Economy 41Transition to a market economy since 1990s, rapidly overcoming initial economic and political difficulties and global financial crisis Geographically land-locked but high growth potential due to abundant natural resources

Vulnerable to commodity booms and busts Need to develop non-mineral sector for sustained growthNeed to strengthen macroeconomic stability41Mongolian Economy (continued) 42

42Mongolian Economy (concluded) 43

4344Implications of Koreas Success44Upheld key principles such as efficiency, openness, long-term planning, and flexibility in designing development strategy

But also tailor development strategy to countrys circumstances

Best utilize countrys comparative advantages (e.g., natural resources, large land area, natural heritage for tourism etc.)

Be mindful of constraints and weaknesses (e.g., volatility of commodity prices, weak fiscal stability, underdeveloped non- mineral sector, etc.) 45

(1) Tailored Development Strategy 45Sustained and efficient investment is key to growth and development.

Investment is the most reliable and robust explanatory variable in growth regressions. Public investment could play a catalytic role in promoting private investment.

SOC investment is crucial for growth take-off while education investment is essential for sustained growth.

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(2) Investment is Key 46Large and sustained public investments in SOC

Investments were initially targeted to growth-hub regions for maximum efficiency before being diversified in the 1980s and 1990s for more balanced regional development.

Investments guided by medium-term Economic Development Plans to ensure continuity and minimize uncertainty

Public-private partnership (PPP) actively utilized in the 2000s to promote efficiency and tap into large private resources for financing47SOC Investment in Korea

47Example: Seoul-Busan Expressway (1968-70)48

The main expressway that connects Koreas two largest cities and other industrial hubs

48Example: Seoul-Busan Expressway (continued)49 Background`Failed to secure financing from World Bank, which rejected funding based on cost-benefit analysis

Turned to domestic funding (including reparation fund from Japan)

* total cost: 42 billion won (16% of annual government budget)

FinancingForward looking investment plan with long-term perspectiveExplosive increase in passenger and cargo transportation amid rapid industrialization

49Example: Seoul-Busan Expressway (concluded)50Revolutionized distribution and transportation network Contributed to regional development and export competitiveness

Set the stage for development of construction and auto industries

Facilitated external funding for subsequent major construction projects (e.g., World Bank changed its view and granted loans for the ensuing construction projects)Results

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51(3) Outward-looking StrategyNonrenewable commodity exports are the main driver of growth in Mongolia at present but cannot be sustained.

Limited base for domestic demand due to small population Development of the non-mineral sector may first target domestic demand but should ultimately be guided by export orientation

Geographic proximity to two large countriesChina and Russiacould be attraction for FDI

51Preserving policy space and flexibility is critical for economic and financial stability against external shocks.

Mongolias heavy dependence on volatile commodity exports puts particularly high premium on policy space.

Fiscal policy should play a major stabilization role in commodity exporters, including managing national wealth for consumption smoothing across generations (e.g., Sovereign Wealth Fund)

Saving windfall gains from commodity booms could help avoid the so-called resource curse.

Monetary policy geared toward price stability under flexible FX regime with due consideration on FX liquidity (foreign reserves)

(4) Preserving Policy Space and Flexibility52

52Maximize the benefits of integration while minimizing the attendant risk

Appropriate sequencing is essential: trade integration first, followed by steady but gradual (and well prepared) financial integration

Continuously upgrade domestic institutions for financial regulation, trade, and foreign investment

Adapting to new global economic and financial order emerging after the global financial crisis(5) Integration into Global Economy53

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Thank You!

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