Economic Miracle: The Economic Development of Germany and South Korea after World War II

An economic miracle is defined as “a period of rapid economic growth that exceeds expectations” (Business Dictionary). Wirtschaftswunder or the “Miracle on the Rhine” by Germany and the “Miracle on the Han River” by South Korea are two of the most popular examples of economic miracles. After World War II, both the German and the South Korean economy were in shambles. Up to 80 percent of German cities were destroyed (Leick “Out of the Ashes”), and 20 percent of all housing; only 51 percent of 1938 food production per capita remained, and industrial output decreased to a third of the 1938 level, (Henderson “German Economic Miracle”) putting Germany in a need to start the country over. Twenty years later, Germany was one of the most developed countries in Europe, moving from fourteenth in the World’s GDP in 1950 to sixth in 1973, with around thirty-two percent increase in GDP per capita (World Bank).

South Korea, after World War II, gained their independence from Japanese Colonization. Unfortunately, the fact that Korea was under Japanese colonial rule for at least thirty-five years prior to World War II caused the Korean economy to be highly dependent upon Japan for capital, technology, and management (Frank 6). Prior to Korea’s independence, Japan owned approximately ninety-four percent of Korea’s total authorized capital of business establishments and employed Japanese engineers and technicians which constituted about eighty percent of the technical manpower in Korea (Bank of Korea “Annual Economic Review”). The rapid separation of the Japanese economy from Korea caused a huge decline in Korea’s economy due to a suspension of many production activities. Like Germany, South Korea also had to start its economy over. Although taking longer compared to Germany, South Korea moved up from thirty-ninth in the World’s GDP in 1950 to sixth in 1980, with around forty-eight percent increase in GDP per capita (World Bank).

This extensive growth in GDP in a relatively short period of time made some economists attribute the title economic miracle both to Germany and South Korea. The purpose of this paper is to elaborate how the rapid economic growth was possible in each country through free market capitalism for Germany and a central planning economy, which later adopted free market capitalism, for South Korea.

The first part of the paper will discuss views that support Germany and South Korea as an economic miracle, in contrast to the view that the rapid growth was due to economic policy and therefore was a product of these policies instead of a miracle. The second part will elaborate each country’s economic development based on timeframes starting after World War II to when the country was acknowledged to be developed or industrialized. Bear in mind, that although in this section will outline the historical events, some economic or major events (e.g.: Korean War, German Reunification, Oil crisis, etc.) may not be elaborated on as much as some of the main economic events that support or undermine the arguments. This section also will describe the economic policy taken by the mastermind of each country: Ludwig Erhard, German Minister of Economic Affairs, and Park Chung Hee, President of South Korea. The third part will explain important economic theories and how they properly explain the economic growth and the growth cycle. This section will analyze all components of Gross Domestic Product (GDP): consumer, government, investment, and net export in terms of how it caused both Germany and South Korea to develop rapidly. The final part of this paper will conclude with an evaluative summary on how each country, Germany and South Korea, rebuilt their economy, achieved rapid economic growth, and finally became developed countries. This section also will cover some preconditions that economists would suggest a country should do in order to obtain greater economic growth through free market capitalism. And finally this paper ends with the argument of whether or not both Germany and South Korea experienced economic miracles.

Economic Miracle

It took Germany around twenty years after World War II to not only rebuild its economy, but also to be one of the most developed countries in the late twentieth century. Some economists would refer this rapid development as an economic miracle, and some would claim this to be the result of a well-implemented capitalism. David R. Henderson supports that Germany’s rapid growth was an economic miracle in the sense that Germany was able to reform the currency and eliminate price controls over a period of weeks in 1948 (“German Economic Miracle”). His theory is that currency reform will end inflation and price decontrol will end repression (Henderson “German Economic Miracle”). This was indeed what Ludwig Erhard, German’s minister of Economic Affairs did. Erhard simply abolished most of the price controls overnight. Because of this, suddenly Germany had a functioning economy again. The black markets disappeared and goods reappeared in Germany’s market. Daniel Yergin in his book The Commanding Heights, cites this “fateful event” as the beginning of the economic miracle and the launching of the social market economy (36). Erhard believed in a free market as the means for economic development and therefore he proposed that the most important role of the government in an economy was to “create incentives for work, savings, and investment” (Herrera 148). In other words, an economic miracle may happen when the economy is freely determined by the market and apart from central planning by the government. Therefore, for Germany, the term economic miracle has mostly been related to Ludwig Erhard’s role in implementing a free market in such a short period of time, regardless of the fact that the economy became worse before finally growing rapidly towards the beginning of the 1970s.

On the contrary, Volker Berghahn argues that the best way to understand the transformation of West German industrial culture in the decades after World War II is to understand it as a process of Americanization and not an economic miracle. On an economic and industrial level, World War II represented a “conflict between an American model of capitalism and a nationalist, authoritarian, and autarkic model of German capitalism” (Berghahn 35). Werner Abelshauser, a German economic historian, argues that the “economic miracle” experienced during the 1950s in Germany represented a reconstruction period in which an initially devastated German economy caught up to normal rates of growth. In other words, the relationship between the social market economy and the rapid growth of the economic miracle was incidental (Van Hook 6). Rolfe Dumke also supports this; to him, what most people called an economic miracle, was in reality a reconstruction growth (85). In this opposing view, one can examine that the focus was on the fact that there was no miracle if Germany was simply correcting and reconstructing the economy to what it should have been. The fact that Germany was able to correct and reconstruct its economy in comparison to other countries was indeed, in itself, an economic miracle.

South Korea’s economic growth took a decade longer than Germany’s post World War II. This is still comparably a lot faster than other Asian countries’ economic growth (disregarding Japan). It can even be said that until today, only Japan, South Korea, and Singapore are considered developed countries in Asia. The economic miracle in South Korea has been mainly attributed to Park Chung Hee, the President of South Korea in the years 1961-1979, and what he did in terms of government policy to promote economic growth.

Before becoming South Korea’s president during the military government, Park was a Major General under the Japanese military (Clifford 1994). Park’s leadership was characterized by a belief in a strong, centralized government that managed the economy and by a strong nationalism (“The Miracle with a Dark Side” 15). In the beginning of his leadership, the United States to some extent worried that Park might be a “closet Communist” because he wanted to implement central planning of the economy by the state. However, the second character, strong nationalism, balanced this “closet Communist” through the rejection of “international communism and the dominance of the Soviet Union” (15). In the article The Miracle with a Dark Side: Korean Economic Development under Park Chung Hee, the writer summarized Park’s belief as “an intense Korean nationalist who believed in the primacy of state power in economics, but oversaw the creation of what were to become very large, privately owned industrial group” (16). In a sense, Park, like Erhard believed in capitalism as the economic system that could help South Korea to be competitive in the World Market.

Unfortunately, South Korea, as a newly independent country post World War II, was not ready to compete in the world market. It was mainly due to the fact that it did not have an economic system (since Japan left it and Korean War that devastated the country even more). Many economists view South Korea as an economic miracle because of their structural transformation to “the ‘free-trade’ policies allegedly implemented in South Korea since the mid-1960s, reluctantly accepting the existence of various forms of state intervention, and the ‘market-friendly’ environment” (Grinberg 711-2). Grinberg further claims that the miracle of South Korea’s development lies in the interaction between domestic and international processes. According to the Economic Landscape, South Korea has gone through many phases of transformation. South Korea went through market liberalization and severe financial crisis cycle, but in the end they came out of the financial crisis and achieved tremendous GDP growth (“Economic Landscape” 40). Another aspect that South Korea was famous for was the fact that they were one of the few that were able to use borrowed money from the International Monetary Fund (IMF) to boost growth and pay back the debt before it was due.

Most of the materials available were dominated by Korean economists or Korean descended economists, therefore the results might be more biased in supporting their argument that South Korea’s economic development was indeed an economic miracle. Kwan S. Kim, a Professor of Economics and Departmental Fellow of the Kellogg Institute at the University of Notre Dame, claims that South Korea’s economic development can be considered a “man-made” miracle. Kim said that “it is a miracle in the sense that in the span of the past three decades the country could achieve the kind of structural transformation (from a subsistence, agrarian economy to a modern industrial power) that today’s industrialized countries took almost a century to achieve” (3).

One of the opposing arguments states that South Korea’s economic growth has been based on the creation of a strong “developmental” state, which directed not only the labor but also the capital, and therefore solved a number of “market failures” by deliberately “getting prices wrong” and by creating specialized institutions (Grinberg 712). In general, South Korea’s economic miracle was largely due to the fact that the government, mainly under Park Chung Hee, did very well in preparing South Korea to gain growth through optimization of capital from both foreign investment and market liberalization. Unlike Germany, South Korea in the beginning stage of their economic development emphasized the government’s role in intervening with the World Market, both through import tariffs and limits, and through tax reduction for exporting firms. The fact that South Korea’s government succeeded in preparing the country to compete and therefore profited from the World Market was indeed an economic miracle.

Economic Policy Timeframe

1. Germany

After World War II, both United States and Britain as the occupation authorities, kept the economic policies of the Nazis. The economic policy prior to Ludwig Erhard and during the transition period from the Nazis, consisted of price controls, rent controls, wage controls, and extensive general regulation of the economy. Price control means that the government regulates the maximum and minimum price to be charged for goods and services, which is “normal” during periods of war and/or inflation. Although effective on a very short-term basis to slow down inflation, over the long-term, price controls lead to shortages (say the goods are primary goods and therefore the demand is high, if the growing demand is significantly higher than the supply, because suppliers can only charge at a certain price, it will eventually lead to shortages), rationing (artificial restriction of raw materials, goods, or services, in other words, making goods and services available although in a very limited amount), quality deterioration (no incentive to provide better goods or service because there is no competition), and black markets (illegal market where controlled or scarce commodities are traded at an extremely high price). Rent control is a price control that acts as a price ceiling to ensure affordable housing for renters that prevents landlords (property owners) from raising prices too much. Unfortunately this discourages the construction of new housing stock and the maintenance of existing property. Wage control (minimum-wage law) is a price floor typically above the equilibrium wage in the labor market that largely affect workers with low skill and little experience (Mankiw 254). In the short-term wage controls may create an increase in income; unfortunately, wage controls lead to a surplus of labor which means there will be a higher number of unemployment because firms will likely hire fewer employees and in more extreme cases, may decrease the work force. Because of these controls, the net result in Germany was an economic disaster mainly due to shortages to the point of near-famine conditions (Watkins “The Economic History of Germany”).

Due to the many controls from the government in the economy, Ludwig Erhard’s economic strategy was the extreme opposite to that of the Nazis’. His first economic policy was the currency reform in which German introduced Deutsche Mark (DM) on June 20, 1948 as the new currency to replace the old Reichsmark. Erhard saw monetary reform as the first step in rebuilding Germany because the drastic decline in Reichsmark buying power. There was too much Reichsmark supply in the economy that unfortunately could not buy anything. People switched to barter as the order of the day, even cigarettes were considered as real currency. The currency reform had to not just reduce the amount of money in circulation, but to restore the function of money as well. Therefore, Erhard expected that the currency reform would help eliminate the black market, create a “more favorable ratio between available goods and the amount of money circulation” (“Currency Reform”), and would also facilitate the Marshall Plan.

With the introduction of currency reform, Germany entered the Social Market Economy – a combination of free market capitalism and social policies to maintain fair competition, in which Erhard abolished many price controls. Price decontrol in theory is considered able to effectively rebuild the economy because first, it brings consumer goods to the market and producing an incredible, though difficult to measure, boost in psychological confidence, i.e., fisher effect where people act on what they anticipate. Suppose that because goods started to show up in the German market, then consumers mostly will assume that the market is doing well, and therefore will be willing to spend more in the market, thus increasing the capital flow and at the end, results in economic growth. Second, price decontrol in theory also takes away crucial power of the military government (Van Hook 142). This is Erhard's main argument regarding government. For government to have too much power in terms of economy is not good for growth because then firms will not be independent, consequently that will be even more burden for the government to constantly figure new policy in order to sustain the economy instead of letting firms worry about it – capitalism.

Through the social market economy, Erhard envisioned the “free movement of prices while allowing exceptional controls on essential consumer goods” (Van Hook 167). In spite of the strong belief in free market economy and therefore allowing very minimal to almost no control from government, Erhard allowed exceptional controls on essential consumer goods because of the fact that supply of goods and services cannot increase overnight, such as that of price decontrol. However, in 1949, Germany experienced serious capital shortages and high unemployment, even after price decontrol was effected.

James C. Van Hook explains what went wrong in his book, Rebuilding Germany: The Creation of the Social Market, that although free market goods started to show up again in the German market, “the economy could not produce enough goods to meet the expected levels of pent-up demand” (160). He argues that there are certain preconditions that Germany should have implemented before abolishing price controls. First, Germany had to make sure that the market has sufficient amount of goods to meet the market demand. Second, there should have been a good distribution network for effective capital, goods, and services flow throughout the country or in other words, good infrastructure. In addition to capital shortage and high unemployment, price decontrol in 1948 caused high inflation in 1949. Erhard would argue that the inflation happened as part of the free market cycle to adjust goods and services price to the world or market price.

In dealing with the high inflation, in 1950s, Erhard began to switch his focus to foreign investment and the implementation of the Marshall Plan – United States effort to provide aids for European countries that were devastated after World War II. Originally, Erhard wanted to provide “freedom” for foreign investors to invest in certain profitable firms. Unfortunately, that only benefited certain firms and not German’s economy as a whole in a short run. The capital from foreign investors mainly went to profitable firms because investors were not sure if other firms, which might have needed the capital more urgently, would give desirable or even be able to give any return on their investment at all. This phenomenon put even more stress on the economic activity because it made the “lack of balance in [German] economic structure ever more evident” (Erhard 665).

To solve this problem, Erhard planned to temporarily “guide the bulk of Marshall Plan counterpart funds to heavy industry, housing, and the transportation infrastructure as a substitute for private capital” (Van Hook 190) until the price stabilized. Erhard claimed that the “economic policy of Germany [in the late 1940s early 1950s was] governed by two major decisions: the financial reform (discussed earlier) and the implementation of the Marshal Plan” (Erhard 665). Erhard’s strategy on investment and the Marshal Plan will be elaborated more in the next section (components of GDP).

On top of using foreign investment and the Marshal Plan aid to gain capital and use it to boost the economy, Erhard also emphasized the importance of firms to take advantage of the high market demand of goods during the Korean War 1950-1952 (will be discussed further in the next section: components of GDP). With capital gains from free market economy, foreign investment, Marshal Plan, and export, Germany allocated the capital to industrialize the country. Germany did this through focusing mainly on heavy industry, such as steel and coal, and technology, mainly machinery. Towards the end of the 1950s, Germany however, succeeded in wiping out its trade deficit (import exceeds export) and even more, was running on a trade surplus. The export material changed from raw materials to mainly manufactured goods. Also, Germany became the major supplier for Western Europe. The German economic miracle lies in the fact that through Erhard, Germany was able to rebuild the economy by adopting social market economy that in the long run solved Germany’s problem of shortages, unemployment, inflation, and on top of that helped Germany industrialize rapidly. After the Oil Recession in 1967, German growth rates declined from the “miracle economy levels” to the normal levels for an industrial economy (Watkins “The Economic History of Germany”).

According to Van Hook there are three reasons why the social market economy worked in Germany. First, the social market reforms of 1948 represented a radical break with Germany’s authoritarian past. Second, the rapid growth was caused by the free market, international trade, high competition, and monetary stability. Third, the rising productivity, which was caused by the introduction of free market relationships had resulted in rising real wages, and thus raised the standard of living of the average Germans (3).

2. South Korea

After the Japanese occupation of Korea ended in August 15, 1945, the immediate postwar period was characterized by the extreme economic disorganization and “economic stagnation caused by the sudden separation of the Korean economy from the Japanese economic bloc” (Frank 6) after thirty-five years of colonial rule. During the year 1946 to 1948, the United States and the Soviet Union, who occupied South and North Korea respectively, tried to create an economy to its liking – Capitalism or Communism. Despite many efforts, neither the United States nor the Soviet Union was able to “rally a majority of Koreans around its favored candidate for national leader (“The Miracle with a Dark Side” 12). Then, in 1947, the northern part of Korea built a strong Communist Party (also called the Korean Worker’s Party) as a manifestation of the resistance movement towards the southern part of Korea. The Communists in the resistance movement acted quickly to eliminate moderate and right wing elements (southern part of Korea or under the United States) to establish Korean Workers’ Party as the effective governing organization in the north. Therefore, to resolve this problem, a formal partition was implemented between North and South Korea.

After the partition, South Korea had its first election as a democratic government. The first elected President was Syngman Rhee in 1948. Although Rhee was born in Korea, he spent most of his life in the United States, especially from the year 1919 until 1941 where he earned his degrees from George Washington, Harvard, and Princeton universities (“The Miracle with a Dark Side” 12). On top of the devastated economic state in the beginning of Rhee’s government, the Korean War that broke in the year 1950-1952 caused even more havoc. The small number of industries that they had left from Japan began to decline even more so during the Korean War. After the Korean War, South Korea’s production relied on primary products, such as agriculture and fishery products. But even this was not enough to meet South Korea’s market demand. The years 1946 to 1953 was characterized by small exports and major imports, especially in food grains and manufactured goods (Frank 10).

Similar to Germany after World War II, South Korea had the same problem of shortages, unemployment, inflation, and black market activities. The shortage in goods was not only caused by low level of supply, but also due to the fact that after the Japanese left, there was a very limited number of skilled people that had the ability to run the infrastructure, and therefore, goods could not be manufactured. Unemployment was high because there was a very limited number of jobs available, and in addition, the immigration of refugees from North Korea caused a rapid increase in unskilled workforce. Inflation was high because the newly created government could not control the money supply expansion. The U.S. military government attempted to help slow down the inflation by implementing price controls: setting maximum prices on essential goods, and rationing the raw materials and goods. Unfortunately, as has been learned from Germany’s experience, price controls did not help the economy, instead they worsened the economy and increased black market activity (Frank 8).

Compared to Germany, who used the Marshall Plan and foreign investment as the backup of capital source instead of as the primary source, South Korea’s capital during 1953 to 1960 mainly came from foreign aid grants such as the United Nations Korea Reconstruction Agency (UNKRA) and the United States bilateral assistance program (Frank 12). During this time period as well, foreign assistance, excluding donations, financed more than seventy percent of South Korea’s economy (12). South Korea did achieve rapid growth in this period, especially in terms of exports. Unfortunately, as previously stated, the high number of exports was largely financed by the injection from foreign investment and therefore can only be considered as nominal economic growth and not sustainable economic growth.

Due to the rough economic development starting period, the military government took over in South Korea, in the year 1961. Under the military government (authoritarian leadership), surprisingly, South Korea followed some of Germany’s footsteps to rebuild the country. Most economists credited South Korea’s economic miracle to Park Chung Hee. Park believed solely in industrialization as the means to achieve economic development. Under Park, South Korea adopted unorthodox measures; relieving “stagflationary pressures quickly by imposing shock therapy – interest hikes, debt rescheduling, ‘industrial rationalization’, devaluation, wage cut, even freezing payments of private sach’ae (curbing markets that do not deal with the normal stock exchange) loans on society, but then using this relief of market pressures only as grounds for another massive injection on government-subsidized bank loans to finance a new round of hypergrowth” (Vogel 3).

Kwan S. Kim, professor at the University of Notre Dame, categorized South Korea’s economy after post wars (World War II and Korean War) into three phases:

i. Import Substitution

The First Phase, Import Substitution, lasted from the year 1954 until 1960. Import Substitution is an effort to substitute imported goods with domestic goods to reduce dependency on foreign capital. During this period, although heavily dependent on foreign capital, South Korea focused on the “building of physical and human capital infrastructures that served as the basis for subsequent industrial development” (Kim 3).

ii. Outward Orientation

The second phase, outward orientation, lasted during the years 1961 to 1979. Outward orientation meant that South Korea switched direction from import-substitution-focused to export-based industrialization. Park Chung Hee, under his military government, led this period:

Park Chung Hee started South Korea’s economic development in 1961 by forming the Economic Planning Board (EPB). He insisted that the deputy prime minister who would head the EPB be a person “with superb technical qualifications rather than a political figure or a high-ranking member of the military” (“The Miracle with a Dark Side” 16) despite Park’s political title and position. The EPB was to create the First Five-Year Economic Development Plan (FYED) announced in 1961 that reflected the basic economic policies in order of priority (Frank 18):

1. Increase in energy supply, including electric power and coal;

2. Increase in agriculture production and in farmer’s income;

3. Expansion of key industries and social overhead capital;

4. National land conservation and development through utilization of idle resources, particularly manpower;

5. Improvement in the balance of payments through the expansion of exports;

6. Promotion of technology.

In this FYEDP, Park also emphasized a big push on the Heavy and Chemical Industries (HCI). Park acknowledges that Heavy and Chemical Industries “constituted the most effective long-term measure to ensure national wealth and military strength simultaneously” (Vogel 119). This was so because of Park’s background. He was educated under Japanese Capitalism, in which he learned that Japan had the power to colonize Asia because they had massive investment on Heavy Chemical Industries that eliminates the dependency of manufacturing from other nations.

In the year 1965, in effort to raise capital to fund the HCI, Park implemented two main strategies. First, he implemented a reverse interest rate where he set the deposit interest rates above loan rates, in the hope that people would save more money. Park doubled the ceiling on interest rates from the previous ceiling, not only to “remove negative effects of low deposits rates in national saving, but also to reduce the curb market and expand the state-owned commercial banks’ share of savings” (Vogel 135). Secondly, Park pursued to normalize the South Korea’s relationship with Japan. Park also introduced the hybridization of foreign ideas – diffusing United States liberal ideas with Japan developmental state (Vogel 19). These two strategies turned out very successful for the development of HCI in South Korea. After the normalization, Japan helped subsidize South Korea’s industrial program by funding the launching of an integrated steel mill.

As for the government’s contribution to develop the HCI, Park made a policy of subsidizing private enterprises (chaebol) that were able to achieve increasingly high levels of export and/or import substitution. Of the two, firms that focused on export expansion received higher priority than the import substitution focused firms. This was so due to the downside of import substitution. Based on the economic theory, import substitution is a strategy that “calls for allocating resources into activities for which the affected nation has revealed comparative disadvantage” (“The Miracle with a Dark Side” 17). This means that import substitution might be “good” in a sense that it promotes local business. On the other hand, it causes the nation to be inefficient in that it could have produced more output when focusing on its comparative advantage.

The second Five-Year Economic Development Plan had a main objective of “[promoting] the modernization of the industrial structure and [building] the foundations for a self-supporting economy” (Frank 19). The major targets were:

1. Food self-sufficiency, reforestation, and development of marine resources;

2. Investment in accelerated and diversified industrialization such as chemicals, machinery, and iron and steel;

3. Further improvement of trade surplus;

4. Restricting population growth through family planning, while at the same time working on increasing employment;

5. Increase farm productivity and income through diversification of farming;

6. Raising the level of technology and productivity by promoting scientific and management skills and eventually improve manpower resources.

The result of the second FYEDP exceeded the expectation by over three percent. This could be also slightly attributed to South Korea’s involvement in Viet Nam war by sending construction workers and troops – boosting both commodity and service export (Frank 20).

In the late 1960s to early 1970s, the world’s economy faced a period of severe financial crisis, which also affected South Korea. Over two hundreds firms went bankrupt in 1971 in spite of the government’s effort to “rescue” over thirty chaebol or conglomerates (Vogel 284-27). In order to keep the economy running, in 1968 and 1969, South Korea signed a stand-by loan agreement of twenty million dollars with the International Monetary Fund (IMF). In return, the IMF demanded policy for the government to implement (Vogel 249) in the year 1971:

• restriction on the inflow of the short-term foreign capital;

• pursue a deflationary fiscal policy;

• devalue the currency from 329 to 450 won per dollar;

• tighten monetary policy;

• reduce bank loans;

• cut government spending;

• abolish export subsidies.

The main reason for IMF to demand these changes was because the South Korean government had been intervening with the market by helping their chaebol through government policy in terms of tax, subsidy, and loans, which caused unhealthy and unfair competition in the world market. Out of all the IMF demands, only the export subsidies abolition was not met, and partially the devalue of the currency where it only reached 371.6 (Vogel 249). The following year, 1972, Park issued an Emergency Decree on Economic Stability and Growth (EDESG) where the government forced the banks to temporarily freeze both principle and interest payment of some main chaebol who were still suffering from the World Recession (Frank 21). Moreover, South Korean government also assisted the near bankrupt chaebol by providing loans and tax cuts through the “Industrial Rationalization Program” (Vogel 230-45). A year later, as a result, the chaebol were relieved from recession and on top of that, some of them increased their exports by almost 100 percent (Vogel 251).

After the economy stabilized and showed reliable growth through exports, Park once again turned his focus to developing South Korea’s Heavy and Chemical Industries. This was manifested in the third Five-Year Economic Development Plant in the year 1972 to 1976. South Korea focused on particular industries such as iron and steel, transport machinery, household electronics, shipbuilding, and petrochemicals (“The Government Role in Economic Development”) in hopes that these industries would reduce and ultimately eliminate foreign capital dependency. During this period, many current massive South Korea firms (chaebol) started to gain more power in the world market, e.g. Hyundai (automotive), Samsung (household electronics), Lucky-Goldstar now LG (household electronics), Sunkyung now TradeKorea (trading place), Daewoo (automotive), and POSCO (iron and steel company) (Sangjin 96).

The Fourth Five-Year Economic Development Plan, 1977-1981, was the turning point of South Korea’s economic system from central planning to free market capitalism. The Economic Planning Board (EPB) publicly announced price decontrol to “correct the distorted incentive structure” (Vogel 230-46) by opening South Korea to trade liberalization – reducing barriers e.g. tariff and quotas on imports and exports. The EPB also announced that the chaebol were to compete effectively in the world’s market by focusing on technology-intensive and high-skilled-labor-intensive industries (“The Government Role in Economic Development”). As a result, South Korea achieved the targeted goal of Heavy and Chemical Industries development two years ahead of schedule (Vogel 228).

iii. Balance and Stabilization

The third phase, Balance and Stabilization, was a response to the “oil-induced worldwide recession in 1980 to 1981 and the crop failure” (Kim 5). Prior to the oil recession also, Park Chung Hee was assassinated in 1979. Both of these events marked the end of South Korea Military Government and the beginning of South Korea democratization (Kamiya 744) as we know today – the Republic of Korea.

Due to the economic crisis, the South Korean government had to impose a stabilization program by “removing subsidies and preferential policy loans, gradually shifting policy concerns to the problem of making rapid growth more harmonious and less wasteful” (Kim 6). In other words, the South Korean government acknowledged that since they finally adopted free market capitalism, government intervention was no longer an applicative solution. Instead, the government allowed and trusted South Korea’s economy in the hands of the chaebol who would develop their own comparative advantages in the world market, which ultimately would lead to economic stabilization. The government could no longer intervene and pick certain chaebol to rescue every time the economy goes wrong. The role of the government in South Korea’s capitalism was to “mobilize and allocate the nation’s resources to enhance national wealth and industrial strength, and to direct private sector activity to … an advanced [capitalism]” (Kim 7).

To summarize, South Korea’s rapid economic growth was largely contributed to dynamic government intervention. South Korea under Park Chung Hee constantly developed economic policy to help the chaebol compete in the world market economy and at the same time, provided the basis support in case of market failure (so that most chaebol will not go bankrupt). This strategy helped South Korea achieve incredible growth although at the beginning of the period was not a reliable growth. It was not until South Korea adopted the free market capitalism, that the chaebol could function properly in running the country’s economy. It was a miracle in a sense that South Korea was able to achieve higher growth than they anticipated even during the implementation of a central planning economy.

Gross Domestic Product to Measure Rapid Growth

Gross Domestic Product (GDP) has been one of the most popular ways used in measuring a nation’s income, and to some extent, can also be used to categorize countries into developed, developing, and underdeveloped country. Gregory Mankiw in Principles of Macroeconomics explains GDP as “the market value of all final goods and services produced within a country in a given period of time” (185) usually in a one year period.

There are two methods to calculate GDP: the total income approach and the total expenditure approach. Both methods will have the same result because total income must be equal to total expenditure (if there is a difference in the result between the two approach, it is due to statistical discrepancy). The income approach calculates the sum of a country’s income from land(rent), labor(wages), capital(interest), and entrepreneur(profit).

The expenditure approach measures “an economy’s total expenditure on newly produced goods and services and the total income earned from the production of these goods and services” (Mankiw 183). To measure the total expenditure, GDP can be divided into four parts: consumption (C), investment (I), government spending (G), and net export (NX). Each of these components are strongly influenced by and dependent on government policy. This section will use the components of GDP with the expenditure approach to explain the rapid growth of Germany and South Korea after World War II.

1. Consumption

Consumption is defined as “spending by households on goods and services, with the exception of purchases of new housing” (Mankiw 187). According to John Quelch, the Charles Edward Wilson Professor of Business Administration at Harvard Business School, government plays a significant role in increasing and/or decreasing the households’ consumption. Government can use “the tax code to nudge [households] to change [their buying] behavior” (Quelch, “How Government Can Boost Consumption”). On top of that, government can also “regulate and legislate compliance” (Quelch, “How Government Can Boost Consumption”).

Germany

There are three regulations that the German government under Ludwig Erhard implemented to boost consumption. First, currency reform in the year 1948. As explained in the previous section, currency reform in Germany was necessary because the old Reichsmark had lost its buying power and therefore households were not able to obtain the goods and services in the German market, despite the fact that there were lots of money flow in the market (Reichsmark had no value anymore). Currency reform, did not only “reduce the amount of money, but [also restored] the function of money” (van Hook 165). The new currency, Deutsche Mark, enabled German households to participate buying goods and services in the market.

The second regulation was price decontrols on goods and services which was strongly insisted by Ludwig Erhard. The logic how price decontrols can boost consumption is as follow: after price control is abolished, for a short time, the price goods and services might increase significantly, which will give incentives to sellers to supply more; but as more goods and services become more available in the market, competition will force the market price down, and as the price decreases, it then would encourage households to spend more.

The third regulation was cutting tax rates. Walter Heller, the tax advisor to the United States military government in Germany (later on became the chairman of President Kennedy’s Council of Economic Advisors in 1961-1964) suggested that reducing tax rate would be beneficial in “[removing] the repressive effect of extremely high rates” (217). Heller advised the German government to flatten corporate income tax, which previously ranged from 35 to 65 percent. Individual income tax was kept at 95 percent, but only for those with income level above DM250,000 annually. In contrast, in 1946 prior to currency reform, the 95 percent tax rate was applied to all income above 60,000 Reichsmarks (equivalent to DM6,000). The mid-income, earning less than DM2,400 annually, were taxed by 18 percent; previously would have been in the 85 percent tax bracket (Henderson “German Economic Miracle”). As we can see, the previous tax rates were incredibly high. This would not in have, in any way encouraged households to make more money. Less income means less money to spend on goods and services, hence lowered households consumption.

South Korea

After the Japanese left Korea, taking along with them most of the capital and the means necessary to keep the country running, South Korea’s productions were limited to agriculture and fishery. Unlike Germany who abolished price control to boost consumption, South Korea who was running heavy on shortages, inflation, and unemployment focused on reverse interest rate where the deposit interest rate is above the loan rate (Vogel 135). This encouraged people to save in the bank instead of taking loans, which increases the capital for government spending.

2. Investment

Mankiw defines investment as the “spending on capital equipment, inventories, and structures, including household purchases of new housing” (187).

Germany

One of the major aids that helped Germany rebuilt its country was the Marshall Plan during the years 1948 until 1960. Unlike most foreign aid or investment, the Marshall Plan did not come in the form of capital or money, instead, the U.S. delivered goods, and provided services (Grünbacher 698). This was done in order to limit the inflation due to shortages in goods and services and the still new currency reform. Another non-monetary investment from Marshall Plan was in promoting Germany’s coal export which was crucial for the reconstruction throughout Europe (703). The Marshall Plan also helped providing housing for the “bombed-out natives” and refugee camps along the border of East and West Germany (704).

South Korea

In the previous section we can summarize that without the help of foreign capital, South Korea would not have been able to achieve the economic growth it achieved. Through aids from United Nations Korea Reconstruction Agency (UNKRA) and the United States bilateral assistance program (Frank 12), South Korea was able to limit the inflation rate, and therefore helped stabilize the economy. Focusing on attracting foreign capital, the government had to pick and choose certain chaebol that were believed to have great prospect in increasing the country’s income through export.

3. Government Spending

Government spending is defined as “spending on goods and services by local, state, and federal governments” (Mankiw 188). The effect of government spending has been attributed to the fiscal multiplier i.e., the “economic analysis of the effects of fiscal policy” (Wilson “Government Spending). The best example would be that through government spending in building infrastructure such as highways, does not only benefit construction companies, but also increase employment, increase income in other sectors such as asphalt, steel, and heavy equipment which in the end theoretically would increase efficiency of the country.

Germany

After implementing social market economy, the German government no longer had significant role in the economy other than facilitating it. Therefore most of government spending was spent on reconstructing Germany’s infrastructure which was heavily focused on transportation networks and housings. Together with the Marshall Plan, in the 1960s, around 570,000 residential units were built each year (“Rebuilding Post War”).

South Korea

Like Germany, the South Korean government also played an important role in reconstructing the infrastructure. The biggest achievement of the Korean military government was the construction of Seoul to Pusan Highway (“Miracle with Dark Side” 31). This was significant because it made the South Korea a one-day town, which meant that it would increase efficiency both in labor and capital movement through the country.

The down side of Korean government spending habit was manifested in the rescue efforts every time the market failed. The government had to reschedule debt and financed the chaebol by freezing the loan payment, meaning that the government had to provide massive subsidy to stabilize the economy.

4. Net Export

Mankiw defines net export as the “spending on domestically produced goods by foreigners (exports) minus spending on foreign goods by domestic residents (imports)” (188).

Germany

In the 1950s and 1960s, Germany became the center of European trades and to some extent even worldwide (export during Korean War). Through focusing on exporting manufactured goods instead of raw materials, Germany achieved trade surplus during 1950s. This export boom was possible due to the fact that German resources and technology were demanded by other nations. Also due to free market which increased the competition and efficiency, Germany was able to produce goods and services at a relatively low domestic cost (Lindlar 220).

South Korea

Two major strategies throughout Park’s era were import substitution and export based industrialization. Import substitution was strongly encouraged mainly due to Park’s goal to not be dependent on other countries and boosting the domestic firms. Unfortunately import substitution is not good for the economy of developing country because it increases inefficiency in production (need more capital to produce something they are not good at in the first place). Instead of increasing the flow of capital, it increased on the nominal capital in the short term.

On the other hand, export based industrialization is indeed an effective strategy to boost the economy, as in the case of Germany. Export oriented firms, will only focus on producing what they are good at. This will create economies of scale where the cost will not increase as production increases due to most likely the efficiency in technology.

Conclusion

World War II destroyed both the German and South Korea economy, infrastructure, and the government system. It took Germany two decades to rebuild its country to become one of the most industrialized nations in the World in the 1970s. A decade later, South Korea also became one of the two most industrialized nations in Asia after Japan. Although both countries achieved rapid economic growth in a relatively short period of time, Germany and South Korea provide two different approaches i.e., social market capitalism and central planning economy.

Under Ludwig Erhard, Germany Ministers of Economic Affairs implemented one very significant government policy that marks the beginning of Germany’s economic development which was the abolishment of price control. This policy was very significant because abolishing price controls, in some sense, voice the reality that they should the government take its hands off of controlling every single aspect of a country. Many people, including the U.S. government in Germany, doubt that immediate price decontrol would actually work. Sure enough as discussed in this paper, although it still experienced ups and downs immediately after abolishing price control, in the long run, Germany achieved the title of a developed country.

On the other hand, South Korea under Park Chung Hee, took another route to become a developed country. Despite his belief in industrialization as a means to achieve economic growth, throughout 1960 until 1980, Park was the one “directing” the economy instead of letting the supply and demand determine the flow of the market. In a sense he was an authoritarian that actually did his role in developing the country.

The best phrase to describe the role of government in South Korea’s economic development would be dynamic intervention of the government. Park conditioned for main chaebol to be able to compete in the world market. And when some of them failed, he would assist them in any way possible, because he believed that to boost economic growth, main chaebol had to be successful enough to later on be the backbone of South Korea’s economy. It was not until major chaebol were able to compete in the world market, that Park ended his dynamic intervention, because they no longer needed to be rescued.

The ability of major chaebol to be independent from Park’s help marked South Korea’s entrance into the free market capitalism. The government no longer control the price of goods and services, but let the supply and demand of the goods to create their own price. This allowed many more chaebol to participate in both domestic and international market and provide sustainable economic growth for South Korea.

One aspect that is similar to both Germany and South Korea other was the fact that both Ludwig Erhard and Park Chung Hee viewed industrialization as key components that would be able to secure economic growth. Although there is no general definition of industrial policy, it may be referred to as the strategy that “[encompasses] almost all policies of state to promote economic growth” (Lee 713-4). The word all shows that there can be more than one approach. It might be social market capitalism as what Germany did, or central planning as in the case of South Korea. Industrialization also meant that a country should participate in “importing, imitating and modifying institutional and technological resources” (Gerschenkron 17).

Finally, as to the question, “did Germany and South Korea actually experience economic miracles or were both nations’ economic growth simply a result of well implemented economic policy?” I would conclude that Germany and South Korea are two countries that did implement their economic policy “effectively”. But I would still attribute the title economic miracle. This is mainly due to the fact that not many nations after World War II were able to achieve rapid economic growth more than anticipated. To say that it was only through well implemented economic policy would give the false hope to every developing country that if they simply follow the economic policy taken by either Germany or South Korea, that country would be successful. If that argument is true, then every country would have done so.

Works Cited

Bank of Korea. “Annual Economic Review of Korea: 1948.” Economic Review (1949):1-100. Web 6 Mar. 2016.

Berghahn, Volker. “The Americanisation of West German Industry, 1945-1973.” New York: Cambridge University Press. 1986.

"Economic Landscape." South Korea Country Profile (2008): 40-58. Business Source Premier. Web. 7 Mar. 2016.

“Economic Miracle”. BusinessDictionary.com. WebFinance, Inc. Web. 11 Mar. 2016.

Erhard, Ludwig. "The Place of Germany." Vital Speeches of the Day 30.19 (1964): 582. MasterFILE Premier. Web. 10 Mar. 2016.

Dumke, R. H. “Reassessing the Wirtschaftswunder: Reconstruction and Postwar Growth in West Germany in an International Context.” Oxford Bulletin of Economics and Statistics 52(2): 451-91. 1990.

Frank, Charles R., Kwang Suk Kim, and Larry E. Westphal. “Economic Growth in South Korea since World War II.” Foreign Trade Regimes and Economic Development: South Korea (1975): 6-24. National Bureau of Economic Research. Web 6 Mar. 2016.

Gerschenkron, Alexander. “Economic Backwardness in Historical Perspective: A Book of Essays.” Boston. Mass: Belknap Press of Harvard University Press. 1962.

Giersch, Herbert, Karl-Heinz Paqué, and Holgar Schmieding. “The Fading Miracle: Four Decades of Market Economy in Germany.” New York: Cambridge University Press. 1992.

Grinberg, Nicolas. "From Miracle to Crisis and Back: The Political Economy of South Korean Long-Term Development." Journal of Contemporary Asia 44.4 (2014): 711-734. Academic Search Elite. Web. 31 Mar. 2016.

Grünbacher, Armin. "Cold-War Economics: The Use of Marshall Plan Counterpart Funds in Germany, 1948–1960." Central European History (Cambridge University Press / UK) 45.4 (2012): 697-716. Humanities International Complete. Web. 10 Apr. 2016.

Heilbroner, Robert. "Economics by the Book." Nation 265.12 (1997): 16. MasterFILE Premier. Web. 11 Mar. 2016.

Heller, Walter W. “Tax and Monetary Reform in Occupied Germany.” National Tax Journal 2.3: 215-231. 1949.

Henderson, David R., "German Economic Miracle." The Concise Encyclopedia of Economics. 2008. Library of Economics and Liberty. 30 March 2016.

Herrera, Stephan. "Erhard's Economic Miracle." Forbes 159.12 (1997): 144-150. Business Source Premier. Web. 10 Mar. 2016.

Kamiya, Fuji. “The Korean Peninsula after Park Chung Hee”. Asian Survey 20.7 (1980): 744–753.

Kim, Kwan S. “The Korean Miracle (1962-1980 Revisited: Myths and Realities in Strategy and Development.” Working Paper 166. Nov. 1991. The Helen Kellogg Institute for International Studies. Web. 31 Mar. 2016.

Lee, Jongseok, Iain Clacher, and Kevin Keasey. "Industrial Policy as an Engine of Economic Growth: A Framework of Analysis and Evidence from South Korea (1960–96)." Business History 54.5 (2012): 713-740. Business Source Premier. Web. 7 Mar. 2016.

Leick, Romain, Matthias Schreiber, and Hans-Ulrich Stoldt. "Out of the Ashes: A New Look at Germany's Postwar Reconstruction." SPIEGEL ONLINE. Der Spiegel, 10 Aug. 2010. Web. 30 Mar. 2016.

Lindlar, Ludger and Carl-Ludwig Holtfrerich. “Geography, exchange rates and trade structures: Germany's export performance since the 1950s”. European Review of Economic History: 217-246. 1997

Mankiw, Gregory. “Principles of Economics, 5th edition. South-Western Cengage Learning, 2011.

Quelch, John A. "How Government Can Boost Consumption." Harvard Business Review. Harvard Business Publishing, 04 May 2009. Web. 2 Apr. 2016.

Sangjin, Yoo, and Sang M. Lee. "Management Style and Practice of Korean Chaebols." California Management Review 29.4 (1987): 95-110. Business Source Premier. Web. 13 Mar. 2016.

“The Government Role in Economic Development” Andrea Matles Savada and William Shaw, editors. South Korea: A Country Study. Washington: GPO for the Library of Congress, 1990.

"The Outlook for Germany." Vital Speeches of the Day 14.21 (1948): 665. MasterFILE Premier. Web. 10 Mar. 2016.

Vogel, Ezra F., and Pyŏng-guk Kim. The Park Chung Hee Era: The Transformation of South Korea. Cambridge, Mass: Harvard University Press, 2011. eBook Academic Collection (EBSCOhost). Web. 8 Mar. 2016.

Watkins, Thayer. ”The Economic History of Germany”. San José State University Department of Economics. California: Silicon Valley & Tornado Alley. 1985.

Wilson, Daniel J. “Government Spending: An Economic Boost?” FRBSF Economic Letter. Federal Reserve Bank of San Francisco, 06 February 2012. Web. 10 Apr. 2016.

Yergin, Daniel and Joseph Stanislaw.” The Commanding Heights: The Battle between Government and the Marketplace that is Remaking the Modern World.” New York: Simon & Schuster Inc. 1999.

#economy #market #capitalism #development #postworldwarII