Government's Role in Korea's Economic Development from a Perspective of the Institutions Hypothesis

Government's Role in Korea's Economic Development from a Perspective of the Institutions Hypothesis

Abstract: This paper divides economic institutions into three categories-coordination institutions, property rights institutions, and contracting institutions- and from this perspective, analyzes the role of government in Korea's economic development from the nineteen sixties to the nineteen eighties. This analysis suggests that the Korean development experience is not in line with the conclusions of Acemoglu, Johnson, and Robinson, since property rights institutions did not play a significant role in Korea's economic development. Instead, the Korean government acted as coordination institutions, which effectively overcame the coordination failure of the market and succeeded in generating effective demand to spur sustainable growth. These results invite further comparative and empirical studies on how Korea came to have a dictator whose goal was consistent with the economic growth of the nation.

INTRODUCTION

Robert E. Lucas, Jr., a Nobel laureate economist, called the economic growth of Korea a miracle in his nineteen ninety-three Econometrica paper, which begins by comparing Korea with the Philippines. In nineteen sixty, these two countries had about the same standard of living, measured by their per capita GDPs, and similarity in many other aspects such as population size, population distribution, school enrolments, industry structure, and export commodities. However, from nineteen sixty to nineteen eighty-eight, GDP per capita in the Philippines grew about one point eight percent per year, while in Korea per capita income grew six point two percent per year. Hence, by nineteen eighty-eight Korean incomes were about three times incomes in the Philippines.

The continuing transformation of the Korean economy and society since the early nineteen sixties has been hailed by many developing countries, which are eager to learn from the Korean development experience. Many books and papers have analyzed factors that contributed to Korea's economic growth; however, a generalization from the Korean experience is not straightforward. An approach based on the Solow growth model delineates potential sources of economic growth in terms of technological progress and accumulation of physical capital and human capital per worker. However, as pointed out by Acemoglu, these factors are only proximate causes of economic growth and success. In other words, earlier analyses based on the Solow growth model fail to explain why the Philippines did not improve its technologies, invest in physical capital, and accumulate human capital as much as Korea did after nineteen sixty.

Hence, we need to understand the fundamental causes of Korean economic growth in order to obtain generalizable lessons from the Korean experience. There are four hypotheses for fundamental causes of economic growth: the luck hypothesis, the geography hypothesis, the culture hypothesis, and the institutions hypothesis. Although the four are complementary, Acemoglu, Johnson, and Robinson show that the impact of European colonialism on economic institutions was the dominant cause of the reversal of economic fortunes among the former European colonies for the past five hundred years.

Acemoglu, Johnson, and Robinson argue that the variations in current economic outcomes are mainly explained by the differences in property rights institutions, measured by average protection against expropriation risk, but do not appear to be affected by geographic variables (including latitude, whether a country is landlocked, and the current disease environment) nor by cultural variables (including the identity of the colonial power, the contemporary fraction of Europeans in the population, and the proportions of populations of various religions). To sum up, the evidence provided in Acemoglu, Johnson, and Robinson supports the hypothesis that institutions are the fundamental cause of economic growth, at least among former European colonies.

This paper analyzes Korean economic development from the perspective of the institutions hypothesis. The economic historian Douglass North defines institutions as the rules of the game in a society or, more formally, as the humanly devised constraints that shape human interactions. His key implications of institutions are the importance of incentives. In a narrower sense, Acemoglu defines economic institutions as encompassing social arrangements, laws, regulations, and policies that affect economic incentives and thus the incentives to invest in technology, physical capital, and human capital. Hence, economic institutions comprise the structure of property rights, the presence and (well or ill) functioning of markets, and the contractual opportunities available to individuals and firms. Following Acemoglu's definition, economic institutions can be categorized as property rights institutions, contracting institutions, or coordination institutions. From this institutions perspective, it is possible to analyze the role of government in Korean economic development from the nineteen sixties to the nineteen eighties.

The institutions approach described in this paper is different from that of Acemoglu, Johnson, and Robinson in that it explicitly considers coordination institutions, based on the belief that coordination failure in the market is widespread in underdeveloped economies and that the government can provide efficient coordination institutions in underdeveloped economies. Specifically, this paper defines government institutions as the policies, regulations, and organizations of the government that are devised mainly to have a proactive role in resource allocations among individuals and firms. In other words, both market institutions and government institutions are considered to be the main coordination institutions in any economy.

This paper defines an underdeveloped economy is one in which institutional failure exists in the sense that the three economic institutions described above are not well developed, but an expansion of aggregate demand can spur sustainable economic growth for a substantial period of time. It defines a well-functioning market economy as one that is characterized by effective property rights and contracting institutions, and in which the market is the coordination institution and the role of government is to step in only when there is market failure.

The next section of the paper discusses the characteristics of the underdeveloped economy. Following that, it reviews the role and the strategies of the Korean government in promoting economic development, demonstrates that property rights institutions were not the key factor in Korean economic development, and presents conclusions about the lessons that can be learned from Korea's development experience.