THE ECONOMY OF THE KOREAN PENINSULA: the Past, the Present, and the Future

1. THE ECONOMY OF THE KOREAN PENINSULA:the Past, the Present, and the Future Yoon-Ho Alex Lee, J.D., Ph.D Law Clerk to Honorable Thomas B. Griffith U.S. Court of Appeals for the D.C. Circuit

2. Objectives • To see how students would benefit from learning about economic history of the two Koreas. • To see how the two Koreas have come to diverge so far in economic performances. I’ll be providing pointers rather than extensive information. • To suggest how we can introduce and tie in basic economic concepts in teaching economic history of the two Koreas.

4. Why Teach High School Students About the Economy of the Korean Peninsula? • Objection #1. Economic history is too difficult for high school history classes … • It requires an extensive background in economics • It requires many complicated concepts and statistics about (arguably) uninteresting sectors. • Objection #2. It’s hard enough keeping up with the current economy. Why bother study economic history? • Objection #3. How interesting can Korea be? It’s not one of the superpowers, like the United States, Japan, China, or the European Union.

5. Why Teach High School Students About the Economy of the Korean Peninsula? • Reply #1. It presents a great opportunity to introduce economic concepts students would otherwise not learn. • You don’t need a Ph.D. to understand the Great Depression or the Dot-Com Boom. • Students learn more economics through history classes than through economics classes. • Reply #2. History revolves around economics and ideologies; history provides good economics. • Reply #3. Korea is an excellent case study and offers insights, history, and lessons no other country can ...

6. Why Korea is an Excellent Case Study . . . • SIZE. Because Korea is a relatively small country, the controlling factors and institutions are clear. There are few hidden variables. • BRIEF HISTORY. The entire history can be traced back to 1953. We can focus on how the two Korea’s different approaches have yielded vastly different results. • TESTING-GROUND. With U.S. & Japan supporting South Korea, and China & Russian supporting North Korea, the Korean peninsula was the “arena” for, or the “focal point” of, the battle of the Cold War ideologies. Korea was a controlled, laboratory experiment of economic ideas, with the ultimate outcome not unlike the resolution of the Cold War. • UNIQUE FEATURES. No other country in history has experienced economic growth like South Korea has over the past 50 years. No other country today has the centrally-planned economy that North Korea does.

7. Suggested Teaching Strategy • STEP #1. BEGIN with a BRIEF HISTORY of the Korean War and the Cold War. Explain the advent of the division between NK and SK, and the states of their economies in the 50s. Emphasize their similarities. • STEP #2. PROCEED on to the CURRENT STATES of their economies. Emphasize their differences. • STEP #3. Explain (1) basic economic concepts and (2) world historical events in conjunction with the economic history. • The key concepts include: factor endowment v. institution, socialism v. capitalism, planned economy v. market economy, perfect competition and perfect information, trade and comparative advantage, long-term investment v. short-term strategies. • The key events include: the Vietnam War, the split of China and Russia, the fall of Russia, world sporting events, and relevant treaties.

8. Suggested Teaching Tips • TIP #1. AVOID (as much as possible) NUMBERS! AVOID all unnecessary references to YEARS. • TIP #2. AVOID (as much as possible) information regarding specific industrial SECTORS. More important is whether these sectors are (1) CAPITAL-INTENSIVE or LABOR-INTENSIVE, and (2) GOODS ECONOMY or SERVICES ECONOMY. • TIP #3. FOCUS on the BIG PICTURE & CONCEPTS rather specifics. SIMPLICITY over PRECISION! • TIP #4. HAND OUT the map of the Korean peninsula. • TIP #5. Frequently ask simple but relevant discussion questions.

9. Step #1: The Two Koreas: In the Beginning . . .

10. Prior to the Korean War • Prior to the Korean War, Korea was colonized by Japan. Japan concentrated its industrial development in northern Korea. • SK was heavily-populated & agrarian; NK was under-populated but rich in resources. South, the center for rice production; North, the center for mining industry. • Although industrialization prompted a brief migration from South to North, many exited North (at the end of WWII) when Soviet gained control over North.

11. SOUTH KOREA Poor in natural & industrial resources Rich in labor force Rich in agrarian land Major Industry: agriculture NORTH KOREA Rich in natural & industrial resources Poor in labor force. Rich in mining land Major Industry: heavy industry The Aftermath of the Korean War *** Apart from imbalance of resource distribution, SK and NK were otherwise similar in climate, geography, size, GNP (both very poor), and institutions.

12. Shared Aspects of the Two Koreas • High Literacy (due to ease of learning Korean characters). • Strong Work Ethics. • Strong Sense of Nationalism. • Confucianism: Family First, Respect for Elders, etc. • One Race – an abiding sense of brotherhood. • Deeply Conformist • Firm Loyalty to Allies (old tradition dating back to the Chinese Dynasty periods)

13. Factor Endowment v. Institution • FACTOR ENDOWMENT LAND, GEOGRAPHY, LABOR, CAPITAL, and ENTREPRENEURSHIP, which can be used for manufacturing. • INSTITUTION Structures of SOCIAL ORDER governing the behavior of individuals. E.g., LAW, CONSTITUTION, PROPERTY RIGHTS. • Think of this as Ingredients v. Recipe? If you want to bake a great cake, you need both. As to which is more important is a hotly debated matter.

14. Step #2: The Two Koreas: Where Are They Now?

15. SOUTH KOREA “The Miracle of the Han River” GDP: $1,200B (11th) GDP/C: $25K % GDP on Military: 2% Labor Force: 25M Major Industries: Electronics, automobiles, chemicals, steel Member of APEC, WTO, and OECD. NORTH KOREA “The World’s Last Centrally Planned Economy” $40B (92nd) $2K 25% 10M Military products, machine building, mining, chemicals As of 2007 . . .

16. Step #3: So . . . What Happened?

17. SOUTH KOREA Labor-intensive Capitalist Reg. Market Economy Open Market Allies: U.S. & Japan Export-Oriented Lucky Breaks: Asian Games, Olympics, World Cup, KOR-US FTA NORTH KOREA Capital-intensive Socialist/Communist Planned Economy Isolationist Allies: Russia & China Self-Reliance Unlucky Breaks: Flood, Drought, Famine, Economic Sanctions A Snapshot Comparison

18. 1950s – 1960s: The Two Koreas’ Divergent Strategies

19. Institution: Socialism v. Capitalism • SOCIALISM Property & distribution of wealth controlled by the community. In an extreme form, it advocates abolition of money, markets, capital, and labor as a commodity. • Objective: Equitable distribution & eradicate poverty. • Concern: No private incentive to exert best effort. • Names: Karl Marx, Friedrich Engels. • Countries: Russia, China, Eastern Europe • CAPITALISM The means of production mostly privately held. • Objective: Growth. • Concern: Poverty concerns. Because rewards are performance-based, there is a winner-take-all concern. • Names: Adam Smith, Friedrich von Hayek, Max Weber. • Countries: U.S., Japan, Western Europe

20. Types of Economic Strategies: Long-Term v. Short-Term • Short-Term Strategy: Pursuing immediate needs to meet production quota. • Concern: There may be no sustainable growth. The country may prosper for three years and collapse. • Long-Term Strategy: Education, building infrastructure, institution reform, etc. • Concern: The country may go bankrupt before ever prospering. The investment may also be misguided or misplaced. • “Give a man a fish; you have fed him for today. Teach a man to fish; and you have fed him for a lifetime.”

21. North: Short-Term & Socialization South: Long-Term & Capitalism • NK: (i) pursues short-term investment strategies and (ii) moves towards socialization. Replete with natural resources but short in human labor, NK’s chief objective is to squeeze maximum labor effort out of its people and to return to its pre-war production level. • SK: (i) pursues long-term investments strategies by borrowing foreign aids, and (ii) moves towards heavily-regulated capitalism. Lacking in natural or industrial resources but abundant in human labor, SK’s chief objective is to educate young talents and borrow ideas from developed countries.

22. North Korea in the 50s-60s • Russia, China, and East European countries provided assistance. The top priority was heavy industry. Why: this made sense as an immediate plan because NK already had remnants of industrial infrastructure built during the colonial period by Japan. By 1957, output levels returned to 1949 levels! • After reconstruction, North Korea sought to industrialize and completed the socialization process in all sectors by 1958.

23. South Korea in the 50s-60s • The Rhee (1st President) Admin. used foreign aid from US to build an infrastructure that included a nationwide network of schools, roads, and a communications network. Why: SK had nothing but farms & surplus workers. • Significantly, SK adopted an export-oriented strategy. Why: SK had poor natural resource endowment & tiny domestic market. The strategy promoted growth through labor-intensive manufactured exports, in which SK could develop a competitive advantage.

24. Why Countries Trade: The Law of “Comparative Advantage” • David Ricardo’s Theory: • Suppose in China, it takes $1 each to make WINE & BREAD; in US, $3 to make WINE & $2 to make BREAD. While it is cheaper to make BREAD in China than in US, it is cheaper still for China to make excess WINE, and trade for US BREAD. US, too, benefits from trade because it still pays $2 for BREAD but it can now get the cheaper Chinese WINE. • Countries benefit by producing products for which their comparative cost is low. E.g., U.S, economy is capital-intensive; Chinese economy is labor-intensive.

25. Interim Reports: As of the late 60s • By all accounts, NK’s economy stayed ahead of SK’s economy in the 50s and this pattern persisted until the mid-70s. SOUTH KOREA • Industrialization left the rural sector relatively underdeveloped. • Increasing income disparity between the industrial and agricultural sectors. • Owed a huge debt to foreign countries. • But by the 60s, it had a well-educated young work force and a modern infrastructure that provided a foundation for growth.

26. Interim Reports: As of the late 60s NORTH KOREA • High growth rates (30% 1 year!) but serious imbalances among different sectors. Because rewards were given to individuals and enterprises that met production quotas, there emerged competition among (rather than within) industries, and an industry that performed better than others did so at the expense of others. .

27. Interim Reports: As of the late 60s Maxed out: Delays and bottlenecks began to emerge, due to lack of arable land, skilled labor & infrastructure. Any further growth required raising productivity, not by working longer hours, but through increased efficiency, an expanded resource base, and technological advances.

28. 1960s – 1970s: SK’s Regulated Economy v. NK’s Planned Economy

29. Planned Economy, Market Economy & Regulated Economy • PLANNED ECONOMY: Government makes all decisions about production and distribution, decides what should be produced and direct enterprises to produce those goods. • Criticisms (Hayek): (i) can lead to totaliatarianism; (ii) planners can never have enough information. • MARKET ECONOMY: “To each his own”: Production, distribution, and pricing decisions are made by private owners based upon individual interests. • Criticisms: Certain market failures, such as monopoly & information asymmetry, are not easily cured. • Smith’s “Invisible Hand Theory” from The Wealth of Nations (1776): The market, while appearing chaotic and unrestrained, is actually guided to produce the right amount of goods as if led by an "invisible hand." • REGULATED ECONOMY: A market economy with general government regulation to protect consumers.

30. General Principle of Microeconomics • The economy achieves its perfection with PERFECT COMPETITION: Where each producer seeks to maximize his profit and each consumer seeks to maximize her enjoyment of consumption, Price of a Good = Production Cost. No waste of resources. Everyone ends up with just enough good for his enjoyment, and production cannot be achieved at a lower cost. • ***But PERFECT COMPETITION requires: (i) a lot of firms, (ii) little product differentiation, (iii) perfect and complete information, (iv) consumers’ equal access to service and goods, (v) firms’ easy entry and exit. Where one or more of these factors fails, the government should aim to cure the defect with economic regulation, e.g., price-setting.

31. North Korea: Planned Economy & Parallel Development of Defense • Kim: Complete socialization  Planned Economy. NK’s emphasis shifted to pursue parallel development of defense capabilities. • Why: Military takeover in SK by Park Chung Hee, U.S. involvement in Vietnam, and the China-Russia split. Thus, the “military first” approach was stimulated by noneconomic concerns.NK was already industrialized in heavy industry. It was thought that stimulating a technological revolution in the munitions industry would promote economic growth and militaristic growth. • Result: In the end, this necessity to divert resources to defense stalled the economy and caused further imbalance of production and has resulted in 1-2% annual growth.

32. South Korea: President Park Chung Hee’s Centralization Plan • Park: Strong Government needed. No other institution has capacity to direct economic changes. • Why: Small Economy, Developing Institutions, Imperfect Information. • Different from NK: A combination of state capitalism & free enterprise. The economy was dominated by a group of large private conglomerates, known as chaebols, (E.g., Samsung, LG, SK, Hyundai) & also by public corporations. • Mechanism: Guide private industry through production targets utilizing the control of credit, informal means of pressure and persuasion, and traditional monetary & fiscal policies.

33. 1970s - 1980s: Two Competing Visions of “Self-Reliant” Economy—Actual v. Potential

34. “No man is an island.” -- John Donne

35. North Korea’s Juche Philosophy • With the China-Russia split, NK moved towards a completely self-sufficient economy. • Juche ideology: “Man is the master of everything and decides everything." Juche literally means “standing alone.” • Application • 1) “People” must have independence in thought and politics, economic self-sufficiency, and self-reliance in defense; • 2) Policy must reflect the will of the masses; and • 3) The most important part is molding people ideologically as communists.

36. North Korea’s Juche Philosophy • NK’s aim was an actually self-reliant economy. Gradually, this led to NK’s isolationist movement, independent R&D, reduced benefit from trade with other countries, and even heavier investment in defense. • Ironically, the Juche economic program resulted in economic dependence. Throughout its history, NK has been an aid-dependent regime. The country was the second largest recipient of international food aid in 2005.

37. South Korea’s Approach • Unlike NK, Park Chung Hee strived for a potentially self-reliant economy. SK cooperated with its allies and took advantage of its labor-intensive competitive advantage to seek an exchange of goods and ideas so that its industrialization can withstand the perturbation in international affairs and the drift. • Application • 1) Workers sent to capital-intensive Middle East; • 2) Students sent to America to study; • 3) Western technologies & financial innovations were readily adopted without incurring independent R&D costs; • 4) SK relied heavily on U.S. for defense.

38. South Korea’s Approach • Large Foreign Debt through the 80s: Of south Korea, Taiwan, Hong Kong, and Singapore, only SK financed its economic development with a dramatic build-up of foreign debt, debt that totaled $50 billion. • Focus on Education: With human capital as SK’s greatest assets, education becomes a status good for society. SK began excelling in International Technology Competitions. • Focus on Exports: In the 80s, South Korea was the most productive economy (per capita) in the world.

39. 1980s - 1990s: South Korea’s Liberalization v. North Korea’s Isolationism

40. South Korea’s Liberalization • OPENING UP THE CULTURE. Tourism began flourishing with ‘86 Asian Games and ‘88 Olympics. A general welcoming of foreigners. • OPENING UP THE MARKETS GLOBALLY. Foreign firms began entering; Korea’s stock market was opened to foreign investments. • ECONOMIC DEREGULATION. The hefty financial & banking regulation introduced by Park was slowly being lifted off. • PRIVATIZATION. The government began selling stocks of the firms it owned.

41. South Korea’s Liberalization • Why It Made Sense: Maturing economy, increasing information cost, more sophisticated institutions, and market imperfections have diminished. Could trust the market to function. • RESULT: • Shift from a goods-economy to a service-economy (restaurants, hotels). • With the end of the Cold War, China and Vietnam emerged as the world labor economy. SK’s competitive advantage of the labor market shifted from low-skilled labor (manual, low-tech) to high-skilled labor (sophisticated, high-tech). • The conglomerates such as Samsung, SK, and LG became critical to SK’s economic health.

42. The 1997 East Asian Financial Crisis • An Inevitable Price?With opening up its markets globally, SK became susceptible to international economic crises. • How Korea Got Over Its Crisis. • Institution Reform w/ emphasis on stability over growth. • The Gold-Drive. People gave away gold to the government in exchange for Korean money; the government sold gold for US Dollars. (“One nation, one race.”)

43. North Korea’s Isolationism • JUCHE, RUSSIA, & CHINA. NK loses strategic trade arrangements with Russia and experiences a strained relation with China (following China's normalization with SK in 1992). • BAD BREAKS: NK experienced record-breaking floods (95 & 96) followed by years of severe drought (97). This, compounded with already-deficient arable land and an inability to import the goods necessary to sustain industry, led to a severe famine. • ECONOMIC SANCTIONS. By 1999 foreign aid reduced the number of famine deaths, but NK’s nuclear program led to a decline in international food and development aid.

44. Looking Ahead:The Economy in the Korean Peninsula in the 21st Century

45. South Korea’s Road Ahead • The IT Industry. The Government began to actively support the IT industry, led by Samsung & LG. • Success in the Semiconductor Industry. Success at home with the development of technology, and abroad, with Korean IT products and services capturing the market share in key sectors. • One of “Next Eleven”. SK has been termed one of the “Next Eleven” economies and is expected to surpass England and France by 2025. • US-KOREA FREE TRADE AGREEMENT (2007). The second largest trade agreement for US, after NAFTA.

46. North Korea’s Road Ahead • The Danger of Another Famine. • Continuously Dependent on Foreign Aid. • Nuclear Non-Proliferation Treaty. In 2005, NK was promised food and fuel aid from SK, US, Japan, Russia, and China in exchange for abandoning its nuclear weapons program and rejoining the Non-Proliferation Treaty. • Still Authoritarian (Mobile TechnologyForbidden). In 2004, mobile phones became forbidden in NK. • Emergence of Capitalism. A small amount of capitalistic elements are gradually spreading from the trial area, including a number of advertising billboards along certain highways.

47. Review:So … Tell Me Again, What Happen?

48. South Korea’s Story • Everything that could’ve gone right did go right. • SK succeeded because … • The 50s-60s’ long-term strategy paid off; • Took advantage of trade and used its surplus labor strategically (produce exporting goods or send labor force offshore); • Regulated its economy when it needed to & Liberalized it just about the right time; • By maintaining a harmonious relationship with U.S. and Japan, it could focus on economic development; • The nation came together as one race in crises; • Received lucky breaks in hosting international events and gaining international recognition; • Made sound judgment calls in shifting its economy’s focus from production industries to service industries.

49. North Korea’s Story • Everything that could’ve gone wrong did go wrong. • NK failed because … • The 50s-60s’ short-term strategy backfired w/ bottlenecks and failed to adopt a long-term strategy; • The country became more and more isolated even from its allies and gave up gains from trade; • Vindication of F. von Hayek: the government can never have enough information to plan the economy; • Russia, lost its own glitter and faced its own demise, and with all of its allies falling apart, the nation had to focus on its defense, eventually ending up with economic sanctions from the U.S. and others. • Unlucky breaks including flood, drought, and famine; • Never sought to induce perfect competition and increase efficiency of the economy.

50. Key Take-Away Lessons from Korea’s Experience • Korea’s experience demonstrates (i) the importance of implementing sound macroeconomic policies, (ii) improving competition through deregulation and market opening, (iii) building a good institutional environment, and (iv) developing human resources. • The value of strong country ownership revealed by the degree of commitment and single-mindedness that Korea has brought to its task cannot be overemphasized. • Korea’s experience is clear evidence that the main vehicle for poverty reduction is growth.