Selected Speeches
Dr. Chungserved as the President of SNU from 2002 to 2006. These are selected speeches during his presidency.
Special Lecture for Renmin University: Globalization and Appropriate Growth Strategies (April 3, 2006)
HIT: 11942
Globalization and Appropriate Growth Strategies - The case of Korea
At the Special Lecture for Renmin University
President Un-Chan Chung
Seoul National University
April 3, 2006
1. Introduction
It is a great pleasure to be here. I am honored that Renmin University of China has invited me to give this lecture today. I would like to use this opportunity to discuss some of the complex issues related to globalization and appropriate growth strategies, and in doing so I will touch on the Korean experience as an example to illustrate my main points.
Today's topic is especially relevant in considering the following two questions: First, is it possible in our present globalized environment for developing countries to join the ranks of the rich nations? And second, if so, what kind of growth strategies are needed to achieve sustained economic growth? According to elementary growth theories, poor countries should grow faster than rich countries in such a way that over time the income gap between those countries gradually narrows. Unfortunately, however, such"convergence" has not happened yet. Rather, we have seen a global"divergence" gradually widen the gap through thecenturies: in 1820 differences in standards of living between the richest and poorest countries of the world were only a factor of 2 to 1, but right now it is about 20 to 1. Since the 1990s, as globalization has increased, differences between countries,as well as within countries, have become more pronounced, with the result that"divergence," or"polarization," has practically been assumed an intrinsic part of the globalization process.
Recognizing this reality, a number of economists came up with the"club convergence" hypothesis, which categorizes nations into different"clubs": the clubs of rich countries, middle income countries, and poor countries. This hypothesis predicts that countries in the same club will tend to converge with each other, while, as a whole, distancing themselvesfrom other clubs. In other words, it is relatively easy to raise income per capita within the confines of a certain income group, whereas it is extremely hard to jump into a higher income group. This hypothesis seems to fit reality: the OECD members have been converging in their income per capita during the last several decades, while the club of OECD and the club of poor countries have been diverging. And there are indeed very few examples of countries which have jumped to a higher income group.
2. Appropriate growth strategies
Since this is the reality that we face, then, it is imperative that we consider what determines the club that a country belongs to. Among the many different criteria, I believe growth strategies is one of the most important determinants."Growth strategies" refers to economic policies and institutional arrangements aimed at sustained economic growth.
The club convergence hypothesis posits that less developed countries have to adopt a growth strategy that focuses on massive accumulation of physical capital, mass education, and the adoption of foreign technologies. This is called an"investment-based strategy." On the other hand, more developed countries should put greater focus on higher education, R&D, and market-based resource allocations, which is called an"innovation-based strategy."
So it is important to notethat a country has to change its growth strategy from an investment-based one to an innovation-based one as it undergoes economic maturation. Otherwise, afailure to shift gears may lead to its becoming trapped at a less-developed stage or in a"non-convergence trap." In order to upgrade and join a club at a higher economic level, a country must change its growth strategies properly and dynamically.
3. Globalization and growth strategies -The case of Korea
Korea's experience in recent years provides us with a good example of how important it is to have appropriate growth strategies thatenable the economy to properly adjust to the rapid changes caused by globalization as well as internal development.
Since the 1960s, Korea has followed an export-oriented growth strategy. Initially it seemed compatible with globalization and was quite successful, enabling Korea to achieve one of the world's highest growth rates for four decades. In particular, the rate of factor accumulation was amazingly high, as Korea's investment rates ranked among the top in the world.
During this time, Korea followed an"investment-based growth strategy," in which the government forced financial institutions to assist in funding investment projects undertaken by the large conglomerates, regardless of their profitability. This was a de facto risk management arrangement whereby everyone in the economy shared the risks involved in the big business investments. The strategy worked quite welluntil the financial crisis of 1997, which put to rest the widespread belief that the high growth rates would continue for decades and allow Korea to join the G7 or G8 club by the year 2010.
As you know, by the end of November 1997, Korea was on the brink of bankruptcy, and foreign investors, having lost confidence in its economy, were pulling out of the country. In retrospect, one might think of this event as only a temporary liquidity crisis. And it is true that in just a few years Korea made a dramatic resurgence, building up the fourth largest foreign exchange reserves in the world.
However, with the clarity afforded us by the passing of time, upon closer inspection, it is fair to say that the crisis occurred due to underlying economic fracture lines that had been created during the years of rapid growth and exposure to globalization. These fracture lines were widened further and became even more precarious due to, the lack of adaptability, or unwillingness even, to adapt to the spread of globalization. There are several factors that contributed to this inflexible posture toward globalization.
First of all, what triggered this massive crisis in Korea was a loss of market confidence, and this was caused by the terrible lack of financial transparency that existed within our globalized financial environment. Korea's big businesses were composed of numerous seemingly independent companies that were interlinked through a web of affiliations and cross-payment guarantees. Their profits were often overstated due to the internal transactions that were taking place between them. Meanwhile, in the case of financial institutions, the magnitude of the bad loans problem was underestimated. Moreover, policymakers refused to admit that the Korean economy had any problems, insisting instead that its fundamentals were sound.
Secondly, there was also inefficiency caused by a failure to observe market principles. For example, the issues surrounding troubled corporations were not handled by the market system but by court mediation, or by applying the Bankruptcy Prevention Accord (whereby banks could defer the dishonor of their bills). Haphazard business practices were prevalent among almost all of the economic players, including corporations, financial institutions, workers, and depositors, mainly because they believed that all of their losses were implicitly guaranteed by the government.
In short, the practices of the main economic players in the Korean economythe financial institutions, big businesses, and the government itselffell far short of global standards, even though these players were deeply involved in the globalized economic environment. Here, let me make it clear that involvement does not necessarily imply thorough adaptation. This characteristic gap between local and global standards was quite simply a symptom of Korea's inability or unwillingness to adapt to globalization. It was only when the Korean economy was faced with the crisis thatmoves were actually made to force it to adapt.
After the crisis, as a condition of accepting the IMFbail-out loans, Korea was forced to adopt painful restructuring measures and had to introduce more market principles in almost all economic areas. Within a few years after the crisis, the Korean economy seemed to be back on track, with GDP growth rates on the riseslightly over 6% in 2002. By this time, much had permanently changed. Banks and big businesses wereno longer 100% protected, and they no longer had the deluded perception that they were 'too big to fail.' Korea was finally becoming better adapted to globalization, and its business practices were more closely aligned than ever to global standards.
However, the story does not have an entirely happy ending. Recently, we've seen the economy suffer from sluggish growth and polarization. It has been pointed out repeatedly that the low growth rates in recent years are the result of poor performance in total factor productivity. Quantitatively, human capital per worker in Korea has reached the level of advanced countries, and so has physical capital. Various estimates tell us that physical capital per worker in Korea ranges from 70 to 90% of the US standard. But, the level of productivity is about half that of the US, and what is more distressing is that this productivity ratio has not improved since the early 1990s, which is what I think lies behind the slow growth we are seeing now. There is also a tendency among big businesses and financial institutions to focus more attention on short-term profits rather than on innovations that would raise long-term productivity. This conservative attitude may be a reaction to the over-investing strategies of pre-crisis periods, but it appears to have gone too far.
As I mentioned, the economy has also become increasingly polarized. While those with higher incomes continueto get richer, many lower income people are beginning to feel that they are worse off than they were even in the days of the financial crisis. These people, the ones with less resourcesand thus, who are less able to cope with the changes wrought by globalizationare the ones who have born the bruntof the changes and restructuring efforts. Because human capital in these middle and lower income classes has eroded, the growth potential of the economy has been hampered this, in turn, has led to society becoming more unstable, threatening to undermine its very integrity. So, while it is true that the financial crisis is over, the economy is even now still adjusting to the internal and external changes, and difficult times arestill being endured by those not fortunate enough to have sharedin the wealth generated by the recovery.
4. New growth strategies and coordination mechanism
I think such problems are to a large extent due to the lack of a firmly established growth strategy. The investment-based growth strategy has reached its limits, but a new strategy suited to this present era, an innovation-based strategy, has not yet been fully implemented.
We have, of course, witnessed the laying of a foundation for this new productivity-oriented strategy, components of which include, for example, more transparency and more markets. But to date this foundation has not served to undergird the rise of an innovation-based strategy. As a result, we see the inferior equilibria of less innovation and more conservatism in firms and banks, the short-term goals of more profits today and smaller demands tomorrow in many markets, and so on. Therefore, I thinkthat a proper coordination mechanism has to put in place if any new growth strategy is to achieve success.
In a very real sense, we can regard proper coordination as being like tacit knowledge. This is because the mechanism through which individual incentives are coordinated is often intangible. Global standards that work well in rich countries can be imported to developing countries, but, in many cases, the tacit knowledge, the intangible elements that form the basis of these well-functioning global standards, is not so readily available, nor are they easily transferable. As an illustration, think about what happens when we import some advanced technology. We buy codified knowledge represented by a set of blueprints. But, there also exists tacit knowledge in the minds of the originating engineers thousands of small details about the workings of that technology, learned over years of experience and transferred from person to person only available through informal training, not in the product manuals. Often the end users that import this new technology are unaware of the extent of this tacit knowledge, so the transfer of blueprints alone, without tacit knowledge, can lead to costly mistakes.
This invisible but important part of a coordination mechanism is sometimes called social capital. The social capital of trust, long-termism, and shared norms, which generate positive externalities for everyone, are needed to ensure that transparency and market principles work properly. Without the proper coordination of social capital, the law of the jungle will prevail rather than market economics, and more inferior equilibria rather than win-win situations. Although it willtake a long process of trial and error to build up a nicely working coordination mechanism, I think political leadership can do a lot to improve things in the meantime, especially in the area of conflict management between the winners and losers of these changing times.
Together with this coordination mechanism, we need to create a new growth engine. This new growth engine will run on innovation, for fresh ideas are what improve productivity. In order for this new engine to work, we need to focus more on investment in R&D and in people with fresh ideas. I will not delve deeper into the many subsidiary issuesthat are pertinent here, but I would like to emphasize that as an economy is being developed it has to focus more on such investments.
5. Concluding remarks
Now, I would like to give brief answers for the two questions that I addressed earlier. First, is it possible in our present globalized environment for developing countries to join the ranks of the rich nations? Yes, developing countries can certainly join the club of rich nations as long as they adopt appropriate growth strategies as the economy develops. And second, if so, what kind of growth strategies are needed to achieve sustained economic growth? The answer is that as the economy is being developed, the focus of investments should continually shift, gravitating toward new ideas and thus encouraging and nurturing innovation in society, with more utilization of market forces.
I would like to conclude by briefly reiterating the concerns we should not forget while developing growth strategies that have been proposed today: what we need for appropriate growth strategies to really work in this age of globalization are not only blueprints but also a proper coordination mechanism, intangible and built on the economy's own unique social assets. Toward this end, hopefully, such values as trust, openness, and cooperation will come to be seen as having equal importance tomarket principles and global standards. With this in mind it is my hope that we will all, Korea as well as China, be able to prosper in this age of globalization. Thank you.
At the Special Lecture for Renmin University
President Un-Chan Chung
Seoul National University
April 3, 2006
1. Introduction
It is a great pleasure to be here. I am honored that Renmin University of China has invited me to give this lecture today. I would like to use this opportunity to discuss some of the complex issues related to globalization and appropriate growth strategies, and in doing so I will touch on the Korean experience as an example to illustrate my main points.
Today's topic is especially relevant in considering the following two questions: First, is it possible in our present globalized environment for developing countries to join the ranks of the rich nations? And second, if so, what kind of growth strategies are needed to achieve sustained economic growth? According to elementary growth theories, poor countries should grow faster than rich countries in such a way that over time the income gap between those countries gradually narrows. Unfortunately, however, such"convergence" has not happened yet. Rather, we have seen a global"divergence" gradually widen the gap through thecenturies: in 1820 differences in standards of living between the richest and poorest countries of the world were only a factor of 2 to 1, but right now it is about 20 to 1. Since the 1990s, as globalization has increased, differences between countries,as well as within countries, have become more pronounced, with the result that"divergence," or"polarization," has practically been assumed an intrinsic part of the globalization process.
Recognizing this reality, a number of economists came up with the"club convergence" hypothesis, which categorizes nations into different"clubs": the clubs of rich countries, middle income countries, and poor countries. This hypothesis predicts that countries in the same club will tend to converge with each other, while, as a whole, distancing themselvesfrom other clubs. In other words, it is relatively easy to raise income per capita within the confines of a certain income group, whereas it is extremely hard to jump into a higher income group. This hypothesis seems to fit reality: the OECD members have been converging in their income per capita during the last several decades, while the club of OECD and the club of poor countries have been diverging. And there are indeed very few examples of countries which have jumped to a higher income group.
2. Appropriate growth strategies
Since this is the reality that we face, then, it is imperative that we consider what determines the club that a country belongs to. Among the many different criteria, I believe growth strategies is one of the most important determinants."Growth strategies" refers to economic policies and institutional arrangements aimed at sustained economic growth.
The club convergence hypothesis posits that less developed countries have to adopt a growth strategy that focuses on massive accumulation of physical capital, mass education, and the adoption of foreign technologies. This is called an"investment-based strategy." On the other hand, more developed countries should put greater focus on higher education, R&D, and market-based resource allocations, which is called an"innovation-based strategy."
So it is important to notethat a country has to change its growth strategy from an investment-based one to an innovation-based one as it undergoes economic maturation. Otherwise, afailure to shift gears may lead to its becoming trapped at a less-developed stage or in a"non-convergence trap." In order to upgrade and join a club at a higher economic level, a country must change its growth strategies properly and dynamically.
3. Globalization and growth strategies -The case of Korea
Korea's experience in recent years provides us with a good example of how important it is to have appropriate growth strategies thatenable the economy to properly adjust to the rapid changes caused by globalization as well as internal development.
Since the 1960s, Korea has followed an export-oriented growth strategy. Initially it seemed compatible with globalization and was quite successful, enabling Korea to achieve one of the world's highest growth rates for four decades. In particular, the rate of factor accumulation was amazingly high, as Korea's investment rates ranked among the top in the world.
During this time, Korea followed an"investment-based growth strategy," in which the government forced financial institutions to assist in funding investment projects undertaken by the large conglomerates, regardless of their profitability. This was a de facto risk management arrangement whereby everyone in the economy shared the risks involved in the big business investments. The strategy worked quite welluntil the financial crisis of 1997, which put to rest the widespread belief that the high growth rates would continue for decades and allow Korea to join the G7 or G8 club by the year 2010.
As you know, by the end of November 1997, Korea was on the brink of bankruptcy, and foreign investors, having lost confidence in its economy, were pulling out of the country. In retrospect, one might think of this event as only a temporary liquidity crisis. And it is true that in just a few years Korea made a dramatic resurgence, building up the fourth largest foreign exchange reserves in the world.
However, with the clarity afforded us by the passing of time, upon closer inspection, it is fair to say that the crisis occurred due to underlying economic fracture lines that had been created during the years of rapid growth and exposure to globalization. These fracture lines were widened further and became even more precarious due to, the lack of adaptability, or unwillingness even, to adapt to the spread of globalization. There are several factors that contributed to this inflexible posture toward globalization.
First of all, what triggered this massive crisis in Korea was a loss of market confidence, and this was caused by the terrible lack of financial transparency that existed within our globalized financial environment. Korea's big businesses were composed of numerous seemingly independent companies that were interlinked through a web of affiliations and cross-payment guarantees. Their profits were often overstated due to the internal transactions that were taking place between them. Meanwhile, in the case of financial institutions, the magnitude of the bad loans problem was underestimated. Moreover, policymakers refused to admit that the Korean economy had any problems, insisting instead that its fundamentals were sound.
Secondly, there was also inefficiency caused by a failure to observe market principles. For example, the issues surrounding troubled corporations were not handled by the market system but by court mediation, or by applying the Bankruptcy Prevention Accord (whereby banks could defer the dishonor of their bills). Haphazard business practices were prevalent among almost all of the economic players, including corporations, financial institutions, workers, and depositors, mainly because they believed that all of their losses were implicitly guaranteed by the government.
In short, the practices of the main economic players in the Korean economythe financial institutions, big businesses, and the government itselffell far short of global standards, even though these players were deeply involved in the globalized economic environment. Here, let me make it clear that involvement does not necessarily imply thorough adaptation. This characteristic gap between local and global standards was quite simply a symptom of Korea's inability or unwillingness to adapt to globalization. It was only when the Korean economy was faced with the crisis thatmoves were actually made to force it to adapt.
After the crisis, as a condition of accepting the IMFbail-out loans, Korea was forced to adopt painful restructuring measures and had to introduce more market principles in almost all economic areas. Within a few years after the crisis, the Korean economy seemed to be back on track, with GDP growth rates on the riseslightly over 6% in 2002. By this time, much had permanently changed. Banks and big businesses wereno longer 100% protected, and they no longer had the deluded perception that they were 'too big to fail.' Korea was finally becoming better adapted to globalization, and its business practices were more closely aligned than ever to global standards.
However, the story does not have an entirely happy ending. Recently, we've seen the economy suffer from sluggish growth and polarization. It has been pointed out repeatedly that the low growth rates in recent years are the result of poor performance in total factor productivity. Quantitatively, human capital per worker in Korea has reached the level of advanced countries, and so has physical capital. Various estimates tell us that physical capital per worker in Korea ranges from 70 to 90% of the US standard. But, the level of productivity is about half that of the US, and what is more distressing is that this productivity ratio has not improved since the early 1990s, which is what I think lies behind the slow growth we are seeing now. There is also a tendency among big businesses and financial institutions to focus more attention on short-term profits rather than on innovations that would raise long-term productivity. This conservative attitude may be a reaction to the over-investing strategies of pre-crisis periods, but it appears to have gone too far.
As I mentioned, the economy has also become increasingly polarized. While those with higher incomes continueto get richer, many lower income people are beginning to feel that they are worse off than they were even in the days of the financial crisis. These people, the ones with less resourcesand thus, who are less able to cope with the changes wrought by globalizationare the ones who have born the bruntof the changes and restructuring efforts. Because human capital in these middle and lower income classes has eroded, the growth potential of the economy has been hampered this, in turn, has led to society becoming more unstable, threatening to undermine its very integrity. So, while it is true that the financial crisis is over, the economy is even now still adjusting to the internal and external changes, and difficult times arestill being endured by those not fortunate enough to have sharedin the wealth generated by the recovery.
4. New growth strategies and coordination mechanism
I think such problems are to a large extent due to the lack of a firmly established growth strategy. The investment-based growth strategy has reached its limits, but a new strategy suited to this present era, an innovation-based strategy, has not yet been fully implemented.
We have, of course, witnessed the laying of a foundation for this new productivity-oriented strategy, components of which include, for example, more transparency and more markets. But to date this foundation has not served to undergird the rise of an innovation-based strategy. As a result, we see the inferior equilibria of less innovation and more conservatism in firms and banks, the short-term goals of more profits today and smaller demands tomorrow in many markets, and so on. Therefore, I thinkthat a proper coordination mechanism has to put in place if any new growth strategy is to achieve success.
In a very real sense, we can regard proper coordination as being like tacit knowledge. This is because the mechanism through which individual incentives are coordinated is often intangible. Global standards that work well in rich countries can be imported to developing countries, but, in many cases, the tacit knowledge, the intangible elements that form the basis of these well-functioning global standards, is not so readily available, nor are they easily transferable. As an illustration, think about what happens when we import some advanced technology. We buy codified knowledge represented by a set of blueprints. But, there also exists tacit knowledge in the minds of the originating engineers thousands of small details about the workings of that technology, learned over years of experience and transferred from person to person only available through informal training, not in the product manuals. Often the end users that import this new technology are unaware of the extent of this tacit knowledge, so the transfer of blueprints alone, without tacit knowledge, can lead to costly mistakes.
This invisible but important part of a coordination mechanism is sometimes called social capital. The social capital of trust, long-termism, and shared norms, which generate positive externalities for everyone, are needed to ensure that transparency and market principles work properly. Without the proper coordination of social capital, the law of the jungle will prevail rather than market economics, and more inferior equilibria rather than win-win situations. Although it willtake a long process of trial and error to build up a nicely working coordination mechanism, I think political leadership can do a lot to improve things in the meantime, especially in the area of conflict management between the winners and losers of these changing times.
Together with this coordination mechanism, we need to create a new growth engine. This new growth engine will run on innovation, for fresh ideas are what improve productivity. In order for this new engine to work, we need to focus more on investment in R&D and in people with fresh ideas. I will not delve deeper into the many subsidiary issuesthat are pertinent here, but I would like to emphasize that as an economy is being developed it has to focus more on such investments.
5. Concluding remarks
Now, I would like to give brief answers for the two questions that I addressed earlier. First, is it possible in our present globalized environment for developing countries to join the ranks of the rich nations? Yes, developing countries can certainly join the club of rich nations as long as they adopt appropriate growth strategies as the economy develops. And second, if so, what kind of growth strategies are needed to achieve sustained economic growth? The answer is that as the economy is being developed, the focus of investments should continually shift, gravitating toward new ideas and thus encouraging and nurturing innovation in society, with more utilization of market forces.
I would like to conclude by briefly reiterating the concerns we should not forget while developing growth strategies that have been proposed today: what we need for appropriate growth strategies to really work in this age of globalization are not only blueprints but also a proper coordination mechanism, intangible and built on the economy's own unique social assets. Toward this end, hopefully, such values as trust, openness, and cooperation will come to be seen as having equal importance tomarket principles and global standards. With this in mind it is my hope that we will all, Korea as well as China, be able to prosper in this age of globalization. Thank you.