From Player to Referee? The State and the South Korean Economy

In 1963, when a wide-ranging economic reform program was initiated by President Park Chung-hee, South Korea’s per capita income level was lower than those of Bolivia and Mozambique; according to the Penn World Tables, by the time of the 1997 financial crisis, it exceeded those of Greece and Portugal. During this period, economic performance was nothing short of spectacular: the country experienced only a single year of negative growth—1980 in the wake of the second oil shock and the Park assassination (figure 1), real per capita income growth measured in purchasing power–adjusted terms averaged more than 6 percent annually, and per capita income stood at more than eight times its level when reforms began.

During this period, the state intervened pervasively in all facets of economic life, from labor and capital markets, to product markets, to international trade and finance, meaning that rapid sustained growth occurred for several decades under a state-led development strategy in which the state was most definitely a “player” in the popular parlance.

Problems arose as the country approached the international technological frontier, and opportunities for easy technological catch-up began to erode. The disappearance of straightforward paths for industrial upgrading based on imitating the prior trajectories of more advanced economies put a heightened premium on the ability of government officials, corporate managements, and their financiers to discern emerging profit opportunities. The old development strategy was no longer adequate, but decades of state-led growth fostered a formidable constellation of incumbent stakeholders opposed to liberalization and transition toward a more market-oriented development model, and in 1997, in the context of the broader Asian upheaval, South Korea experienced a financial crisis with net clean-up costs that eventually amounted to 16 percent of 2001 GDP.

One might have anticipated that a shock of this magnitude would have contributed to thoroughly discrediting the old model, but old habits die hard: There is a two-way relationship between individual attitudes or preferences and local policies and institutions (Alesina and Fuchs-Schundeln 2005). Local practices influence individual’s perceptions of the world, and individual’s beliefs condition the politically acceptable bounds of policy. Because of the self-reinforcing nature of this feedback loop, change tends to come only slowly. Once established, it can take generations for local beliefs to converge toward

broader international norms. Perhaps conditioned by a history of pervasive intervention in the economy, South Koreans appear to have high expectations about what the public sector can deliver, but in a 2004 survey, business executives identified “policy instability” and “inefficient bureaucracy” as the two most problematic factors in doing business in South Korea (figure 2). With growth slowing and the polity seemingly afflicted by a kind of malaise, South Korea could be facing a situation in which the reputation-derived “Korean discount” acts as a semi-permanent self-reinforcing drag on economic performance.

This is the awkward legacy that the state-led model has bequeathed South Korea: Like an aging football star, the state can no longer be the player it once was—the game has simply become too fast and complex—but it seems unwilling or unable to trade in its player’s cleats for a referee’s whistle.