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Based on ADB Staff Paper 61 dated February 1994.  Many of the  following are quotes from  the article even though they do not have quotation marks.

    During the export period 1962 to the early 1980s, though export-promotion was strongly undertaken, most commodity prices---interest rates, exchange rates and wage rates---were not able to change freely in response to market conditions of supply and demand but were controlled by the government. Market disequilibria prevailed in the economy. In this regard, it might be safe to say that Korea's export-led growth (ELG) strategy did not necessarily involve a free market system with equilibrium prices.

    The 1994 ADB study found that for most of the time before the mid-1980s, the Korean won had always been overvalued in light of relative inflation between Korea and its major trading partners[1]. The disadvantageous effect on exports of the persistently overvalued exchange rate was partly or completely offset by two kinds of government support for exports:

(i)   ad hoc export promotion system

(ii)  psychological encouragement by President Park

  The South Korean government provided an "assured" economic climate that is similar to the "social climate" of Schumpeter in which creative, innovative entrepreneurs receive high social prestige in addition to a high rate of income (abstract section).

  There were four periods in the evolution of the Korean Economy:

(1)  1950s: The Period of Rehabilitation

(2)  1960s: The Period of Outward Orientation

(3)  1970s: The Period of Diversification

(4)  1980s: The Period of Structural Adjustment

  During the Period of Rehabilitation, 1950s:

Korea was then among the poorest countries of the world. The primary concern then was rehabilitating the infrastructure and manufacturing capacity that was virtually destroyed by the Korean War (1950-1953). Primary industry and the services industry comprised 85% of total output. Services industry comprise 40-50%, mainly attributable to a large number of skilled workers hidden in retail and other services that did not require expertise. Primary industry output was 47.3% in 1953 with the percentage being maintained until the mid-1950s and thereafter declining slightly. More than 2/3 of exports were traditional products and primarily  crude materials such as unprocessed minerals.

  During the Period of Outward Orientation, 1960s:

The most salient feature of the Development Plan was to regard exports as the locomotive of growth. The first measure undertaken was the provision of tax and financial incentives for exporters. The second measure  (for promoting exports) was to devaluate the Korean won by nearly 100%, from 130 won per US dollar to 255.77 won in 1964.  Although the exchange rate of the won moved from 65 won per US dollar to 130 won in 1961, the won had been at that level for several years and eroded the international competitiveness of Korean products, especially under an inflation rate averageing 18% during the period 1961 to 1964. The third measure (1967) was the creation of a favorable export environment by shifting the import control system from a positive list system to a negative list system which lessen the difficulties of exporters in importing necessary intermediate materials and investment goods for producing goods for export. The third measure was the last step towards the liberalization of imports. During the period, trade ratio (a combined ratio of exports and imports as a percentage of GNP) rose sharply from 14% in 1962 to 31% in 1970. Meanwhile, the portion of primary industry in total production decreased within the period. Composition of manufactures in exports increased, mostly light industrial products such as textiles and footwear.

  During the Period of Diversification, 1970s:

It was in the 1970s that the Korean economy experienced the most significant changes in all areas, especially trade, industry, and finance. The changes can be characterized by diversification of economies, especially industry and trade, together with expansion of production and trade volume. First Measure: In 1972 government declared a repayment moratorium for debts of corporations from unofficial financial markets and reduced the debt burden of corporations in the process. Second Measure: development of heavy and chemical industries. In the 1960s, light industry had grown rapidly, playing a key role in boosting exports, generating employment and increasing national output. Despite the advantages inherent in light industry, particularly its labor-intensiveness, light industry also revealed two disadvantages. First, it created a relatively small amount of value added because most items, such as apparel, footwear and plywood, were heavily depended upon imported raw and intermediate materials. Second, increased investments in light industry expedited the import of capital goods, which aggravated the balance of payments. To address the problems, the government promoted import substitution for intermediate materials and capital goods, and eventually developed a new source of exports on which Korea would rely. In 1973, the government announeced the Heavy and Checmical Industry (HCI) Development Plan, which outlined the need, scope, and implementation program for developing future strategic industries, including shipbuilding, automobiles, steel products, machinery, non-ferrous metals, and petro-chemicals. The government provided varied incentives in finance, tax and tariff to the firms which initiated HCI projects. As for financial incentives, the government established the National Investment Fund which provided long-term loans to strategically selected heavy and chemical industries. While the Fund was partly funded by government, much of it was funded through a compulsory transfer of private deposits from the commerical banking institutions to the Fund. Free entry to certain areas of heavy and chemical industries was prohibited. High tariff barriers were set up in order to protect the "infant" industries. Strong tax incentives were given to firms which spent resources for training workers and for R&D to strengthen production technology. As a result of the efforts to build the HCI, the share of the heavy and checmical industry in the total output of the manufacturing sector rose from 33% in 1970 to 50% in 1980. Exports, which in the 1960s comprised light industrial products such as textiles and footwear, by the 1970s were showing some HCI products (such as electronics, machinery, ships, and iron and steel products) as important items. However, as a result of the efforts to build the HCI, foreign debt increased leading to a sharp increase in the debt service burden. Inflation was also high at 16-17% annually in the 1970s.

The Korean economy exhibited many positive features in the 1970s, but on the other hand it also revealed severe problems, including high inflation, a high degree of government intervention in economic operation, low efficiency, and increasing foreign debt burden. It was a widely accepted view that the main cause of those problems was the overlapping, excessive, and inefficient investment in the HCI, under an interventionist government policy. Most of the firms in the HCI was operating at production capacity much below their full utilization, causing enormous business loss and heavy debt-service burden. As the government began a bail-out of firms, it further intervened in management of some firms. Under the circumstances, there arose a strong demand for structural adjustment of the economy.

  During the Period of Sectoral Adjustment, 1980s:

The main thrust of the demand was characterized by liberalization, deregulation, and internationalization of the economy on the grounds that further heavy government intervention would be neither desirable nor effective in the light of the already sophisticated and large-sized Korean economy. It was further argued that the production efficiency of the Korean economy should be raised by having price mechanism play a principal role. In addition, pressure from foreign countries to open the Korean markets mounted from the early 1980s.

DEREGULATION AND INTERNATIONALIZATION OF THE ECONOMY The government took several important steps toward deregulation and internationalization of the economy.

(i)     First, to open domestic markets and to stimulate competition in the economy, it reduced import barriers to a considerable extent by lowering tariff rates and increasing the numbers of importable items without any authority's approval. The average tariff rate was down to 20% in 1985 from 39% in 1978, while the import liberalization ratio, i.e., the percentage of the importable items without prior approval in the total commodity items classified for custom use, rose from 68% in 1979 to 92% in 1986.

(ii)    Second, financial incentives to export industries and the HCI were reduced dramatically to heigthen the self-sustaining capability of these industries (policy-based loan occupied a substantial portion of total domestic credit, reflecting a variety of financial incentive systems provided to a wide range of industries including the export sector, HCI, and small and medium industries. This brough a distorted allocation of financial resources, impairing the independent operation of commercial banks and preventing flexible monetary policy). 

LIBERALIZATION OF THE FINANCIAL SECTOR. Together with a drastic reduction of financial incentives, liberalization of the financial sector was initiated through privatization of the five commercial banks and the lowering of barriers against foreign banks' entry into the Korean financial markets.

ROLE OF STABILIZATION.  Another important change in macroeconomic policies in the mid-1980s was to emphasize stabilization of the economy, compared with the previous policy in the 1960s and 1970s which had focused upon economic growth. Money supply, on average, had kept a high growth rate in the 1970s, with this trend continuing into the early 1980s (as reflected in Appendix Table A6 of the ADB Report). However, the rate of growth in M2 sharply declined from 1983 onwards. In addition, during 1983-1986, under an austerity program, government spending, was cut, leading to a dramatically lowered budget deficit ratio as a percentage of GDP. Along with the tight monetary and fiscal policy, inflation was reduced from a double digit rate to less than 5% from 1983 onwards[2].

The structural adjustment and stabilization efforts in the 1980s were thought to have been successful. Since the mid-1980s, the Korean economy had demonstrated dramatic price stability and huge surpluses in the current account, while maintaining high-growth momentum (indicated in Appendix Table A7 of the ADB Report). This is in view of the decades-long experience of high inflation rates and large deficits in the current account since the 1960s. From 1986, exports began to increase by about 30% per year, resulting in large trade surpluses. Several factors accounted for these sharp increases in exports. First, a radical appreciation of the Japanese yen occured in 1985, corresponding to the Plaza Accord of the Group-7 countries. The appreciation played an important role in improving the international competitiveness of certain Korean products (namely, steel, cars, electronic consumer durables, and semi-conductors) which were competing with Japanese products in the international markets. The second factor was the improved quality of Korean manufactures, ascribed to technological development, R&D efforts and government's support and enthusiasm for the HCI in the 1980s. For the ADB report, last but most important was the Korea's economic reforms, geared towards liberalization, internationalization, and stabilization of the economy. These contributed to the strengthening of the international competitiveness of Korean products through stabilized price and enhanced efficiency.

  Re Disequilibria in Foreign Exchange and Financial Markets:

Financial Market. Before the mid-1980s, all types of interest rates of banks and non-bank financial institutions were determined by the Ministry of Finance or the Bank of Korea (Central Bank). By the mid-1980s, liberalization had begun in a phased manner. The official interest rate set by the monetary authorities was mostly lower than that of the unofficial financial market, where the interest rate was determined by market forces, giving a sign that the official rate was somewhere below an equilibrium rate. Therefore, the official markets always faced excessive demand for funds, causing a disequilibrium credit rationing by financial institutions.

Foreign Exchange Market.  Korean adopted an exchange rate system in which until 1980 foreign exchange rates were pegged to the US dollar. In January 1980, a trade-weighted currency basket system was  introduced. During the dollar-pegging period, the exchange rate was determined by the monetary authority, being reviewed and adjusted from time to time. Under the trade-weighted currency basket system which was employed from January 1980 to March 1990, the exchange rate was determined basically by the movements of currencies of major trading partners such as the US, Japan and the Federal Republic of Germany. Only in March 1990 was a kind of free market exchange rate system introduced, though the system still imposed a band within which the exchange rate could fluctuate in a single day.

For most of the history of the exchange rate system in Korea---until March 1990---the exchange rate was determined not by market forces but by monetary authority or by movements of the currencies of trade partners. The exchange rate did not reflect the demand/supply situation. The Korean won was overvalued for most of the period from 1962 to early 1980s[3].

  Re Role of Government in Export Promotion

The roles undertaken by the Korean government can fall into the following categories:

(i)     operating dand developing the economic infrastructure---energy, transportation, and communication, etc.

(ii)    developing and stimulating human resources and people's aspirations

(iii)   presenting medium and long-term targets for economic developpment

(iv)   promoting strategic industries, including agriculture, small and medium industry, and key manufacturing sectors

(v)    enhancing the productivity of the overall economy---boosting the R&D efforts, modernizing production technology, and disseminating information on domestic and foreign economies

What factors offset the disadvantage associated with the persistently overvalued exchange rate while encouraging Korean manufacturers to increase their sales of goods and services to foreign markets?

(i)     financial and tax incentives (until the early 1980s)

(ii)    psychological encouragement