In a recent statement David Cameron showed his lack of grounding in basic economic history when he said Africa should follow the mythical Korean model of growth through free trade.
Cameron said: “Freer trade in Asia gave Korea space to grow.”
The truth is the opposite. Much of Korea’s massive increase in GDP happened because of protectionist state control according to the highly respected Korean Economist Ha Joon Chang and others.
In South Korea development was state led. The government exercised control over the banks to ensure that they served industry rather than seeking profit for themselves. The government also discouraged consumer loans whilst encouraging long-term saving.
This meant the government could target investment to favoured industries, which gave them the financial security to follow long-term development plans. The government also ensured all large companies were always domestically majority owned meaning that profits would stay within the country.
The government followed a programme of ‘infant industry protection’, a term coined by the 19th century economist Friederich List. He argued that, like children, young developing industries need to be protected by their governments until they grow strong enough to compete with other mature foreign industries.
South Korea protected its infant industries in a number of ways. It gave them cheap finance, removed tariffs on their imported raw products needed for manufacture, gave them tax breaks and imposed heavy tariffs on competing imports.
Importantly, such help was entirely dependent on results. Productivity and imports had to increase and industrialists that failed faced jail. The state encouraged development that benefited the country rather than making individuals wealthy, though it still did make some people very rich.
The South Korean government also strictly controlled what type of industry they favoured at what time. All the supported companies were export orientated and once an industry had matured help was withdrawn and transferred to another infant industry.
The timing of the government’s support for infant industries was also very important. Initially they supported lower tech industries such as those producing cement and fertilizers, once they matured and could compete globally help went instead to heavier industries such as those producing petrochemicals and steel. When they matured their help was withdrawn and it went instead towards shipbuilding and semiconductor manufacture.
Real problems only started when South Korea removed the tight controls on its financial markets. As Nobel prize winning economist Joseph Stiglitz said in his book Globalization and its Discontents: “Under pressure from the United States it [South Korea] had reluctantly allowed its firms to borrow abroad. But by borrowing abroad, the firms exposed themselves to the vagaries of the international market.”
Large unregulated flows of money from international banks flooded into the country and South Korea soon accumulated foreign debts of $150 billion, most of it private and short-term. This inflow of money also caused a price boom in share and property prices.
In 1997 hedge funds started speculating on the Thai baht, this speculation soon spread to other Asian countries including South Korea. Repelling the speculation reduced the country’s foreign reserves before it was finally forced to reduce the value of its currency.
This caused jitters amongst some international financial investors who then withdrew their funds, other investors panicked and followed suit.
This herd-like behaviour of international finance makes it potentially very damaging, as was the case in South Korea, where worries of a crash became self-fulfilling.
The sudden withdrawal of funds caused the property and stock markets to crash. Other problems included a much heavier debt burden on companies and banks that had borrowed in foreign currencies. This led to more non-performing loans which weakened the banks and resulted in less lending to businesses. Inflation also rose because the price of imports increased due to the weakened currency.
Finally South Korea had to turn to the IMF for help.
Cameron is right in that Korea can teach us lessons in development, unfortunately he cannot see what it has taught us.
Far from showing us that freer trade is a good thing it shows us the perils of opening up markets to unregulated financial institutions.
If he and other politicians had correctly learned the lessons of the East Asian financial crisis and introduced more regulation of finance the worst of the UK financial crisis might have been avoided.
It also shows us that government intervention is not always a bad thing.
That Cameron does not realize this makes one wonder quite what grasp he has over the reasons behind the financial crash in Britain.
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