Sectoral dynamics of industrial policy in a two-sector economy: the case of Korea’s heavy and chemical industry (HCI) promotion (1973–1979)

Abstract

This study explores the impact of state’s industrial policy on sectoral capacity utilization and growth in total output in the context of the Korea’s Heavy and Chemical Industry (HCI) promotion (1973–1979). Using a Kalecki-Steindl framework within a two-sector open economy, the study first finds that primary industrial policy instruments—preferential interest rates and export promotion regime—have a positive effect on capacity utilization (aggregate demand) and economic growth, but unbalanced sectoral dependence undermines the effect of industrial policy. Second, the increased market power of firms in the targeted sector has a dual impact on the sectoral capacity, depending on the productivity growth characteristics of each sector. Third, the industrial policy regime is highly susceptible to adverse external price shocks. These findings are consistent with the Korean growth experience during the HCI promotion period in which chaebols (big business groups) flourished, and the economy suffered from stagflation and idle capacity in the final stage of HCI promotion.

Keywords:

• Industrial policy
• sectoral capacity utilization
• market power
• Kalecki-Steindl framework
• South Korea
• heavy and chemical industry promotion
• external price shock

JEL CLASSIFICATION CODES:

• C62
• E12
• E22
• E25
• O25
• O41

Acknowledgment

This paper is based on a chapter of my PhD thesis, which was submitted to Dalhousie University in 2023. I extend my sincere thanks to two anonymous referees for their valuable comments. My gratitude also goes to Lars Osberg, Dozie Okoye, and James McNeil for their essential advice and unwavering support, and to Marc Lavoie, Hiroshi Nishi, Peter Ho, and Michalis Nikiforos for their encouragement and insightful feedback. I appreciate the engaging discussions at the 56th Canadian Economics Association conference, the Inaugural Tracy Mott Workshop at the University of Denver, the PPE Seminar at Mount Allison University, and the 27th FMM Conference. Any remaining errors are my responsibility. Lastly, special thanks to Tracy Mott whose introduction to Kalecki has profoundly influenced my academic journey.

Disclosure statement

No potential conflict of interest was reported by the author(s).

Notes

1 “Economists Reconsider Industrial Policy” Project Syndicate, Aug. 4th, 2023. See also Juhász, Lane, and Rodrik (2023) for the review of the recent literature on industrial policy.

2 The state designated several key strategic fields: electronics, automobiles, shipbuilding, machinery, petrochemicals, iron and steel, and nonferrous metals as a backbone of the economic development plan. This agenda was called “The Five-Year Economic and Social Development Plan,” and the HCI promotion policy was enacted through the third implementation period of the plan (1972–1976) and the fourth period (1977–1981).

3 The literature also points out that from a geopolitical perspective, officials also needed to adopt a more proactive approach than the labor-intensive export promotion strategy used in the 1960s. The Nixon Doctrine, the first significant military withdrawal of 20,000 out of 61,000 US troops by June 1971 (see Letter From President Nixon to Korean President Park at National Archives, Nixon Presidential Materials, XIX, Part 1: https://history.state.gov/historicaldocuments/frus1969-76v19p1/d58), further fueled policymakers’ interest in heavy and chemical industrialization. Horikane (2005) regarded the HCI promotion policy as politically rational, grounded in the prevailing geopolitical circumstances.

4 Kim and Topel (1995) points out that the lagged real-wage growth behind productivity indicates that government efforts to suppress wage growth for less skilled workers was effective at least until 1975.

5 The estimation of labor share can differ depending on the treatment of self-employed income, particularly in countries like Korea with a high proportion of self-employed individuals. Gollin (2002) offers three methods: (i) treating self-employment income solely as labor income; (ii) aligning self-employment income with the labor income proportion of other sectors; (iii) equating self-employment income to the average wage of wage earners whose number is obtained from the data. The figure is based on the estimation of Lee et al. (2014) and Lee (2015) who adopts the second method, arguing that the third option overstates labor share since the real data (from 1975) indicates non-wage earners’ per-capita surplus is consistently below employee compensation. The Bank of Korea (BOK) uses the first method, potentially overestimating the labor share by not accounting for capital owned by the self-employed.

6 There are some Kaleckian literature that added unit interest costs to unit labor costs when applying the markup (e.g., Godley and Cripps 1983; Godley and Lavoie 2007). One issue, however, concerns what really determines the real normal profit rate: is it the nominal interest rate or the real interest rate that is relevant? (Lavoie 1995). Kalecki himself did not think interest rates played much of a role, because he thought that interest rates did not significantly vary through the business cycle.

7 See Appendix Section A for the algebraic notes for the profit ratio.

8 While the assumption of zero depreciation is useful for short-run models, it is worth noting that it is a significant departure from the real-world phenomenon of physical capital wear and tear, and other factors that result in the depreciation of capital. Over longer time horizons, the effect of depreciation can become increasingly important, and accounting for it becomes necessary in more detailed models of investment and growth that aim to capture the long-run evolution of the capital stock and the level of output. However, the model does not take this depreciation factor into consideration for the sake of simplicity.

9 Recall $\frac{\partial \mathbf{C}}{\partial p}=\frac{{\pi }^H-1}{{\Delta }^2}<0.$

10 See Appendix Section A for the algebraic derivations of the relative unit labor cost ratio.

11 According to Auty (1992), the HCI Drive seeks to accelerate the sequence of backward integration from light industry through capital-intensive intermediates into skill-intensive machinery and engineering. An HCI Big Push is even more ambitious since it seeks to capture the externalities arising from simultaneous entry into HCI sectors at different stages in the production chain.

Additional information

Notes on contributors

Joseph Chul-kyoo Jung

Joseph Chul-kyoo Jung is a postdoctoral fellow at Saint Mary’s University, Nova Scotia, Canada.