04/11/2011

From Aid to Development in Korea: Ownership and Policy Innovation

October 7, 2011 Joon-Kyung Kim KDI School of Public Policy and Management

Contents
1. Koreas Broad based Economic Transformation 2. Taking Ownership of Development Process 2.1 Anti-Corruption via Tax Reform 2.2 Policy Innovations 3. Lessons from the Korean Experience

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1. Koreas Broad based Economic Transformation

Broad Based Development (1/3)

Koreas rapid growth was accompanied by relatively low income inequality.
<Gini coefficient and GDP per capita growth rate: 1965-1990>
Gini coefficient
0.7 0.6 0.5 0.4 0.3 0.2 0.1 0 0 1 2 3 4 5 6 7 8 PeruChile Venezuela Argentina Colombia Mexico Ma la ysia Philippines Tha ila nd Indonesia Singa pore Hong Kong Korea Ta ipei, PRC

Bra zil

Per capita GDP growth rate (%)

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Broad Based Development (2/3)

Role and impact of foreign aid was critical, and had profound and lasting impact on Koreas development.
After liberation from Japan in 1945, Korea suffered depression, hyperinflation, and civil war, which can make any country poor.

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Foreign aid helped fill the financing (income) gap: * Humanitarian role of aid was invaluable, preventing starvation and disease. * Aid was also critical in laying the basic foundations for economic growth; massive investments financed by aid helped raise Koreas capital stock (including human capital and physical infrastructure). - Educated and healthy work force was bedrock of Koreas industrialization.

Broad Based Development (3/3)

But foreign aid alone does not explain Koreas economic development. Just as important was Koreas initial conditions (institutional setting) before economic take-off and sustained development.
Land reform (redistribution of land to poor) under US Military Government resulted in relatively flat distribution of income and wealth, it leveled the playing field rearranged of Koreas institutional setting. * Income stability in the rural sector meant farmers could afford to send their children to school. * Less concentration of economic and political power meant that the state or other self-interested group could not be obstacle to development.

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2. Taking Ownership of Development Process 2.1 Anti-Corruption via Tax Reform 2.2 Policy Innovations

Aid dependent and government failure

In fact, Korea became too dependent on aid and suffered widespread government failure.
Korean government was addicted to aid: * Overvaluing its currency to maximize aid receipts while printing money to finance budgets. This resulted in persistent high inflation and macro instability. Corruption and crony capitalism in government and business were widespread. Government had become an obstacle to economic reform and progress.

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Taking Ownership of Development (1/4)

President Park undertook systematic anti-corruption campaigns to clean up government bureaucracy and dismantle government-business network of crony capitalism Tax Administration Reform was perhaps the single most important government action early in Koreas development.
By early 1960s, foreign aid accounted for 50% of government budget, and economic aid to Korea began to decrease and the economy suffered high inflation as government printed money to meet budget needs. At the time, Korean tax collection was poor due to corrupt tax officials and lack of mindset and culture of paying taxes among Koreans. Indeed, tax collectors would show up and demand taxes arbitrarily without any records or documents while the idea of paying taxes was foreign to most Koreans.

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<Box 1> Tax Administration Reform in the mid 1960s

Tax Administration Reform was key initiative of anticorruption efforts.
* Korean tax system and personnel was reorganized and restructured. * NTS (National Tax Service) motto was Sound tax base, Compliance, and Education * Corrupt or incompetent tax officials were relocated, demoted or dismissed. * Tax reporting and bookkeeping was emphasized to promote voluntary self-compliance and assessment of taxes.

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NTS Mission Statement

Words of encouragement to NTS Commissioner hand written by President Park:

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1.

See gold as a stone

Sound Tax Revenue Base

2.
Compliance

3.
Education

Taking Ownership of Development (2/4)

Implications of Tax Administration Reform cannot be overemphasized. It led to sound fiscal base, changed government behavior and addressed government failures.
In 1966, when NTS was established, tax revenues increased by 67% from 1965. In 1967, 1968, and 1969 tax revenues increased by 48%, 51%, and 39%, respectively. Tax burden ratio (tax revenue/GNP) : 1964 (7.3%) 1970 (14.6%) Expanded tax revenues meant fiscal soundness, which led to: * Macro stability and manageable inflation. * Foreign borrowings could be secured to finance export based industrialization. * Government could coordinate and implement social and economic policies for broad based development (i.e. rural development policies).

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<Box-2> Implications of Fiscal Soundness

< Government revenue, expenditure, and fiscal surplus>
(% of GDP)

Expenditure

Revenue

Taking Ownership of Development (3/4)

Foreign borrowings (savings) was critical to Koreas rapid industrialization. Korea had to rely on foreign borrowings due to low domestic savings, and lack of foreign receipts and foreign currency reserve.
Early on, Korean businessmen could not secure foreign borrowings to finance capital investments, to buy foreign equipment. Not even the governments Foreign Loan Repayment Guarantee Act in 1962 did much to induce foreign borrowings.

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Against fierce opposition, President Park normalized relations with Japan in 1965 to get access to foreign capital, technology and know-how.

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<Box-3> Comparison of Korea and Taipei, PRC:

< Investment and Savings in Korea (%)>
53~59 Investment/GNP Domestic Saving/GNP Foreign Saving/GNP Foreign Saving/investment 13.1 3.7 9.4 71.7 62~66 16.3 8.0 8.3 50.9 67~71 25.4 15.1 10.3 40.6 72~76 29.0 20.4 8.6 29.7 77~81 31.0 25.5 5.5 18.1 82~84 28.2 24.8 3.4 12.1 85~91 32.7 34.8 -2.1 -6.4

Source: Cho and Kim (1997), Lee Dae-Geun (2002)

< Investment and Savings in Taipei, PRC (%)>

1951~60 1961~70 21.9 21.1 0.8 3.7 1971~80 30.5 31.9 -1.4 -4.6 1981~90 22.3 33.3 -11.0 -49.3 1991 22.2 29.5 -7.3 -32.8 16.1 14.9 1.2 7.5

Investment/GNP Domestic Saving/GNP Foreign Saving/GNP Foreign Saving/investment

Taking Ownership of Development (4/4)

As part of normalization, Japan committed to US$ 800 million of foreign assistance (colonial reparations): US$ 300 million in grants, and US$ 200 million in concessionary loans and US$ 300 million in commercial loans.
Japanese aid (reparations) were allocated with efficiency and ownership.
To prevent misuse of funds for political purposes, the Law of Operation and Management of Japanese Reparations" was established. * Most serious offense was punishable by death. This law proved effective in deterring corruption and misuse of the funds. Key implications: * Japanese aid was critical is building POSCO, centerpiece of Koreas industrialization.

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* Repayment of aid loans allowed Korea to build a track record as a creditor, which allowed it to induce future foreign loans.

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POSCO (Pohang Iron and Steel Co.)

Gyeongbu [Seoul-Busan] Express Way

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<Box 4> Allocation of Japanese Reparations Fund

Japanese aid (reparations) allocated with efficiency and ownership.
Project Agriculture (irrigation and agricultural production expansion program) Fishery (fisheries promotion and fishing boat construction) Manufacturing Construction of POSCO Purchase of raw materials (textiles, fertilizers, chemicals, etc) Promotion of SMEs Science and Technology Equipments for practical training for the vocational schools Equipments/facilities at KIST Social Infrastructure Construction of Soyang-River Dam Gyeongbu Expressway Improvement of Railway system Construction of Yongdong Thermal Powerhouse Expansion of Waterworks (Kwangju City, Taejeon City, Cheongju City) Construction of Namhae Bridge Rehabilitation of Han-river Bridge Power Distribution facilities Expansion of out-of-town Telephone lines Total (Reparation funds in the form of grant and public loans)
Source: EPB (1976), White Book on Reparations Fund pp. 378-381

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Amount ($ Mil) 39 27 278 119 133 22 20 6 3 90 22 7 20 2 4 2 1 4 4 500

Ratio (%) 7.8 5.4 55.6 23.9 26.5 4.5 4.0 1.2 0.6 18.0 4.4 1.4 4.2 0.4 0.8 0.4 0.2 0.7 0.8 100.0

Policy Innovation (1/2)

With the fiscal soundness and addressing govt failure, the govt could play a coordinating role by undertaking a set of deep and wide complementary interventions and reforms.
One of the important government policy innovations that led to broad based and sustainable development was its rural development policy via Saemaul (New Village) Movement.

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By 1970, urban income was 60% higher than rural income, and 50% of the population still lived in rural areas.
To improve rural living standards, the government initiated the Saemaul Movement based on the basic principles of cooperation, self-help and self-reliance. It was important to improving living standards(roads, bridges, electricity, water, sanitation) but also building social capital (trust, leadership).

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Policy Innovation (2/2)

Saemaul Movement was a community and a merit-based Approach of rewarding performance.
At first, all villages were given resources (cement, etc.) free of charge by the govt to make use for community project. Then, only villages that volunteered, worked together to improve their villages were designated as self-help villages and rewarded by being given additional resources. Electricity was provided to villages that showed positive outcomes. In less than 10 years, 97% of the villages had secured access to electricity. To widen access roads to villages, private land owners voluntarily donated some of their land to widen the roads after long and difficult process. Once the first land owner donated land, who was usually the most wealthy in the village, others were persuaded to follow by doing the same. Then villagers volunteered their own time to help widen the roads.

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<Annex 1> The Saemaul Projects <Box 5> Priority of SaemaulMovement

<Hypothetical Layout of a Typical Village and Saemaul Project Undertaker >

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1. Village access roads 2. Old bridges 3. Village roads 4. Sewage system 5. Thatched roofs 6. Old fence of farm house

7. Traditional Wells 8. Village halls 9. Banks of brook 10. Feeder roads 11. Rural electrification 12. Village owned telephone

13. Village owned hot bath 14. Childrens playground 15. Cloth washing place 16. Planting of trees

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Villagers cooperated and volunteered labor in building roads, bridges, and making composts

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Public list to show villagers that donated land for village access road

The village access road captured President Parks vision of bringing social and economic transformation In 1970, President Park remarked: is there a hope in a village where villagers should walk carrying things on their back when they enter the village, because they do not have a village access road for a truck?

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<Box 6> Parasite Infection Rate in Korea

Parasite Infection Rate in Korea (%)
90 80 70 60 50 40 30 20 10 0
1969 1970 1971 1972 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995

2 25 16 18 25

3. Lessons from the Korean Experience

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Lessons from Koreas Experience (1/2)

Broad based development means ensuring that growth in a market economy is accompanied with broad social benefits. Growth policies also need to ensure poverty reduction, social equity, environmental quality, factors that make a more open and tolerable society (more sustainable).
Koreas experience shows the importance of taking ownership of

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the development process, which as defined under the DAC principles means Developing countries set their own development strategies, improve their institutions and tackle corruption. There is no better example than the Korean government taking ownership of tax administration reform, the importance and implications of which cannot be over emphasized. Productive allocation of Japanese aid (reparations) also show the importance of taking ownership and the invaluable role that aid play in assisting developing countries.

Lessons from Koreas Experience (2/2)

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But undertaking transformational change is not only about the level of activities (more or less investment) but also about the kinds of behaviors (beliefs) and institutions that individuals adopt (Hoff 2000). The anti-corruption campaign and performance-based programs of the Saemaul Movement illustrate the potential role in policy interventions as a way to coordinate better outcomes. As in Koreas case, development requires a set of complementary changes across multiple sectors.

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