Foreign Economic Relations

Foreign Economic Relations

Exports were the key to South Korea's industrial expansion. Until 1986 the value of imports was greater than exports. This situation was reversed, however, in 1986 when South Korea registered a favorable balance of trade of US$4.2 billion. By 1988 the favorable balance had grown to US$11.4 billion. Financing this persistent, although not unexpected, gap between domestic and imported resources was a principal concern for economic planners. In the 1950s and 1960s, much of the trade deficit was financed by foreign aid funds, but in the last two decades, borrowing from and investment in international capital markets have almost completely substituted for economic aid.

Aid, Loans, and Investment

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. 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) 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, 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.

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.

Foreign Trade Policy

Seoul stated in 1987 that its foreign trade policy was structured for further expansion, liberalization, and diversification. Because of the paucity of natural resources and traditionally small domestic market, South Korea has had to rely heavily on international trade as a major source of development. Seoul also sought to diversify trading partners to ease dependence on a few specific markets and to remedy imbalances in the present tendency to bilateral trade.

Exports and Imports

The rapid growth of South Korea's economy in the late 1980s led to significant increases in exports and imports. In the wake of the 1988 Seoul Olympics, South Korea's trade surplus exceeded US$11 billion and foreign exchange revenue had increased sharply. Seoul's trade with communist countries surged in 1988. Trade with Eastern Europe was US$215 million, trade with China almost US$1.8 billion, and trade with the Soviet Union US$204 million.

In 1989 total exports grew to US$74.29 billion, and imports totaled US$67.21 billion. South Korea's annual trade exceeded US$100 billion for the first time in 1988, making it the world's tenth largest trading nation.

During the 1960s and early 1970s, the commodity structure of Seoul's principal exports changed from the production of primary goods to the production of light industrial goods. After 1974 there was a rapid expansion in the production and export of heavy industrial and chemical products. By 1986 the share of heavy industrial and chemical products in total exports had expanded to 55.5 percent (as compared to 18.9 percent in 1980) whereas the share of light industrial products had shrunk to 40.9 percent (as compared to 71.1 percent in 1980).

South Korea had depended greatly on the United States and Japan as its major trading partners, with 75.6 percent of all exports going to these markets in 1970. Success at diversifying export markets led to a reduction in the United States-Japan export market share to 55.6 percent in 1986. The Middle East accounted for 12 percent of South Korea's export trade from 1972 to 1977, but its share declined to 5.2 percent in 1986 because of the collapse of the construction boom in the Middle East and the Iran-Iraq war (1980-88). Exports to Western Europe declined from 18.8 percent in 1979 to 15 percent in 1986. Exports to developing areas, such as Latin America (0.8 percent in 1972; 3.6 percent in 1986) and Oceania (0.9 percent in 1972; 1.4 percent in 1986), grew.

Indirect Seoul-Moscow trade was estimated at about US$20 million in 1978, with Moscow importing electronics, textiles, and machinery and exporting coal and timber. By the late 1980s, South Korea's global fur trader, Jindo, was expected to produce US$20 million worth of fur garments annually in a joint venture with the Soviet Ministry of Light Industry. South Korean businesspeople were offered such Soviet products as instruments for nuclear engineering and technology for processing mineral ores and concentrates. In the first ten months of 1989, bilateral trade between Seoul and Moscow reportedly increased 156 percent from 1988 figures to US$432 million.

Since the early 1960s, the structural pattern of imports had shown changes, particularly in the relatively decreasing share of imported consumer goods and the accelerated growth of industrial supplies and capital equipment imports. The share of consumer goods imported in 1962 was 24.1 percent of total imports; this share declined to 9.8 percent of total imports in 1986 because of increased South Korean production of these goods for the domestic market. The declining share of raw materials as a percentage of imports during the early 1970s was reversed in 1974 because of the increased value of oil imports (caused by the 1973 war in the Middle East). By 1979 crude oil was 25 percent of South Korea's total import requirements. This figure dropped to 8.4 percent in 1988 because of the use of other sources of energy and the decline in the price of petroleum in the late 1980s.

South Korean exports to the United States in 1988 rose to US$21.5 billion, a 17-percent increase over 1987; imports rose to US$12.8 billion, a 46-percent increase over the 1987 level. The percentage of total South Korean exports destined for the United States market decreased to 35.3 percent in 1988 from 38.7 percent in 1987. At the same time, the United States' share of total South Korean imports rose to 24.6 percent, up from 21.4 percent in 1987. By 1988 Seoul's favorable balance had grown to more than US$8.7 billion.

In 1989 imports rose to US$57 billion (up 18 percent from 1988) whereas exports reached US$61 billion, a 2-percent increase from 1988. The trade surplus was reduced from US$11.5 billion to US$4.3 billion and was projected to decline even more. Invisible receipts rose 10 percent, but payments, mainly reflecting a big increase in South Korean travel abroad, were up 20 percent. Thus, the surplus on invisible trade was reduced from US$1.3 billion to US$400 million.


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