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South Korea Table of Contents

South Korea

Aid, Loans, and Investment


Sixty-three-story Daehan Life Insurance Building, a popular tourist attraction and one of the tallest buildings in Asia
Courtesy Oren Hadar

Foreign economic assistance was essential to the country's recovery from the Korean War in the 1950s and to economic growth in the 1960s because it saved Seoul from having to devote scarce foreign exchange to the import of food and other necessary goods, such as cement. It also freed South Korea from the burden of heavy international debts during the initial phase of growth and enabled the government to allocate credit in accordance with planning goals (see The Post War Economy , ch. 1). From 1953 to 1974, when grant assistance dwindled to a negligible amount, the nation received some US$4 billion of grant aid. About US$3 billion was received before 1968, forming an average of 60 percent of all investment in South Korea. As Park's policies took effect, however, the dependence on foreign grant assistance lessened. During the 1966-74 period, foreign assistance constituted about 4.5 percent of GNP and less than 20 percent of all investment. Before 1965 the United States was the largest single aid contributor, but thereafter Japan and other international sponsors played an increasingly important role.

Apart from grant assistance, other forms of aid were offered; after 1963 South Korea received foreign capital mainly in the form of loans at concessionary rates of interest. According to government sources, between 1964 and 1974 such loans averaged about 6.5 percent of all foreign borrowing. Other data suggested a much higher figure; it seemed that most loans to the government were concessional, at least through the early 1970s. International Monetary Fund (IMF--see Glossary) data showed that imports financed through such means as foreign export-import loans with reduced rates of interest totaled 11.6 percent of all imports from 1975 to 1979. The aid component of these loans was only a fraction of their total value.

During the mid-1960s, South Korea's economy grew so rapidly that the United States decided to phase out its aid program to Seoul. South Korea became increasingly integrated into the international capital market; from the late 1960s to the mid- 1980s, development was financed with a series of foreign loans, two-thirds of which came from private banks and suppliers' credits. Total external debt grew to a high of US$46.7 billion in 1985. Positive trade balances in the late 1980s led to a rapid decline in foreign debt--from US$35.6 billion in 1987 to an expected US$23 billion by 1991. Account surpluses in 1990 were expected to enable Seoul to reduce its foreign debt from its 1987 level of about 28 percent of GNP to about l0 percent by 1991.

United States assistance ended in the early 1970s, from which time South Korea had to meet its need for capital investment on the competitive international market and, increasingly, from domestic accounts. The government and private industry received funds through commercial banks, the World Bank (see Glossary), and other foreign government agencies. In the mid-1980s, total direct foreign equity investment in South Korea was well over US$1 billion.

The fact that South Korea was so dependent on foreign trade made it very vulnerable to international market fluctuations. The rapid growth of South Korea's domestic market in the late 1980s, however, began to reduce that dependence. For example, a dramatic rise in domestic demand for automobiles in 1989 more than compensated for a sharp drop in exports. Furthermore, while Seoul's huge foreign debt left it vulnerable to changes in the availability of foreign funds and in international interest rates, Seoul's economic and debt management strategy was very effective.

The South Korea's philosophy concerning direct foreign investment had undergone several major changes tied to the changing political environment. Foreign investment was not allowed through the 1950s. In 1962 the Foreign Capital Inducement Act established tax holidays, equal treatment with domestic firms, and guarantees of profit remittances and withdrawal of principal. Despite the provisions of the act, there was little foreign investment activity until after the establishment of diplomatic relations between South Korea and Japan in 1965.

Seoul had to mobilize both external and internal sources when it launched its First Five-Year Economic Development Plan in 1962. The Foreign Capital Inducement Act was amended in 1966 to encourage a greater inflow of foreign capital to make up for insufficient domestic savings. A rapid inflow of investment followed until 1973, when the act was changed to restrict the flow of investments. Beginning in the late 1970s, however, the government gradually began to remove restrictions as domestic industries began to grow and needed to be strengthened to cope with international competition. But until the early 1980s, South Korea relied heavily on borrowing and maintained a somewhat restrictive policy towards foreign direct investment.

Donald S. Macdonald has pointed out that under the liberalization policy, restrictions on foreign direct investment were eased in 1984 and 1985. Seoul changed its control policy on foreign investment from a "positive list" to a "negative list" basis, which meant that any activity not specifically restricted or prohibited was open to investment. An automatic approval system was introduced under which all projects meeting certain requirements were to be immediately and automatically approved by the Ministry of Finance.

Seoul twice revised the negative list system after its initial introduction--first in September 1985 and again in April 1987--to open more industrial sectors to foreign investors. In 1984 there were 339 items, or 34 percent of the 999 items on the Korean Standard Industrial Classification, on the negative list. As of July 1987, there were 788 industrial sectors open to foreign investment. In the manufacturing sector, 97.5 percent of all industries (509 out of 522) were open to foreign investment.

In December 1987, Seoul announced a policy to liberalize the domestic capital market by 1992. The program called for liberalizing foreigners' investment funds, offering domestic enterprises rights on overseas stock markets, and consolidating fair transaction orders. Seoul planned to allow direct foreign investment in its stock market in 1992.

Of the total direct investment in South Korea from 1962 to 1986, which amounted to US$3.631 billion, Japan accounted for 52.2 percent and the United States for 29.6 percent. In 1987 Japan invested US$494 million, or 47 percent of the total foreign investment of US$1.1 billion. Japan invested mainly in hotels and tourism, followed by the electric and electronics sector. Direct investment from the United States showed a remarkable increase since the early 1980s, accounting for 54.4 percent of the 1982-86 total investment. The United States invested a total of about US$255 million, or approximately 24 percent of the 1987 investment. Cumulative United States investment was about US$1.4 billion by 1988.

There was a dramatic rise in foreign investment in the late 1980s. Approvals of foreign equity investments reached an all- time high of US$1.283 billion in 1988, a 21 percent increase over 1987. As in previous years, approvals for Japanese investments were the dominant factor; they totaled US$696 million (up 41 percent from 1987), followed by United States investors with US$284 million (up 11 percent), and West European sources, US$240 million (up 14 percent). Investment approvals in the service sector doubled in 1988 to US$561 million, which included two large Japanese hotel projects totaling US$344 million. Investment approvals in the manufacturing sector, however, declined from US$775 million in 1987 to US$710 million in 1988.

South Koreans began investing abroad in the 1980s. Before 1967 there was virtually no South Korean investment overseas, but thereafter there was a slow growth because of Seoul's need to develop export markets and procure natural resources abroad. In the 1970s, South Koreans invested in trading, manufacturing, forestry, and construction industries. By the early 1980s, a sharp reduction in development projects in the Middle East led to a decline in South Korean investment there. Mining and manufacturing investments continued to grow throughout the decade. In 1987, out of a total South Korean overseas investment of US$1,195 million (745 projects), US$574 million was invested in developed countries and the remaining US$621 was invested in developing countries.

One of the most noticeable economic achievements in the 1980s was Seoul's reversal of the balance of payments deficit to a surplus. This improvement was largely attributable to strong overseas demand for South Korean products and to the reduction in expenditures for oil imports. In addition, the "invisible" trade account (monies from tourism and funds sent home by nationals) had improved considerably in the late 1980s because of temporary increases in revenue from tourism, receipts from overseas construction, and structural decreases in interest payments (see table 5, Appendix).

South Korea's success in achieving a balance of payments surplus, however, was not without some drawbacks. It led to harsh trade disputes with the United States and other developed nations, as well as to inflationary pressures. To cope with these problems, Seoul had to modify its enthusiastic promotion of exports in favor of a policy restraining trade surpluses within reasonable limits.

An important measure restraining the growing foreign trade imbalance between South Korea and the United States was Seoul's decision to revalue the won against the United States dollar. A stronger won made American imports cheaper, increased the cost of South Korean exports to the United States, and slowed, but did not reverse, the growth in the South Korea-United States trade deficit as of 1989. The United States pressed for further appreciation of the won in 1989. In April 1989, the United States Department of the Treasury accused South Korea of continued "manipulation" of the South Korean currency to retain an artificial trade advantage. South Korean officials and businesspeople, however, complained that the already rapid appreciation of the won was slowing economic growth and threatening exports. In May 1989, South Korea avoided being called an unfair trader by the United States and forestalled possible United States trade sanctions, but the nation paid a high price by promising to open up its agricultural market, ease investment by foreigners, and remove many import restrictions (see table 6, Appendix).

Data as of June 1990

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