From the 1960s to the 1970s, industrial output in almost all Third World countries grew rapidly. Growth was especially fast in a subset of developing countries that can be called ‘late industrializers’, countries which industrialized without the competitive asset of being able to monopolize an original technology. Late industrializers include South Korea—the subject of this article—Taiwan, India, Brazil, Mexico, and possibly Turkey. (Japan also qualifies as a late-industrializing country because it, too, started to grow without indigenous technology.) Since the 1980s, stagnation has afflicted the economies of most late-industrializing countries and those of the Third World in general. Yet Korea and Taiwan have continued to grow very rapidly, posing a special puzzle for those who seek to understand different patterns of growth in the world today. Dependency theories of economic development, for instance, have been unable to explain East Asia’s rapid growth, predicting instead underdevelopment as a consequence of international trade and foreign indebtedness; yet exports have been pivotal in the rapid economic expansion of all the East Asian countries, and Korea’s economy has also been highly leveraged on international loans. Nor have market theories of economic growth demonstrated greater explanatory power.

The most orthodox economists have interpreted East Asian expansion as a vindication of free-market principles. ‘Export-led’ growth is seen as reflecting comparative advantage, a pillar of free-market theory.footnote1 More broad-minded economists among the orthodox have been less complacent, however, recognizing the need to modify the free-market explanation because government intervention in the fast-growing East Asian economies has been so extensive. Nevertheless, such economists have argued that despite this widespread government intervention, the East Asian economies have not violated the canons of free-market theory and have ‘got relative prices right’; that is, they have allowed the forces of supply and demand to push prices of key resources, such as foreign exchange and capital, close to their equilibrium or scarcity levels. They argue that conformity to free-market principles is what accounts for East Asia’s rapid economic advance.

In fact, there is little evidence to support the more liberal of the orthodox interpretations. In the case of Korea’s exchange rate, even if it were never grossly overor under-valued, exporters were generously subsidized by the government and strongly coerced to export through an export targeting system. Thus, the amount of exports and the dol lar price received for them were highly politicized outcomes. In the capital market, government policy was equally ‘distortive’. One of the first acts of the Korean strongman, Park Chung Hee, after he seized power in a coup d’état in 1961, was to nationalize the banking system. This gave him control over domestic interest rates, exclusive of those which prevailed on an informal ‘curb’ market. He also gained control over the allocation of foreign loans, targeting them to specific industries earmarked for development, and even to specific firms that were both efficient and generous friends. He gained control over foreign loan allocation because foreign lenders required government guarantees of repayment in the case of default, and the Korean government used its guarantee powers to determine which firms could borrow abroad.

Because the rate of inflation exceeded the rate of currency depreciation, the real interest rate in Korea on long-term foreign loans throughout most of the expansionary decades of the 1960s and 1970s was negative. In a capital-scarce country, a negative real interest rate on investment capital cannot be interpreted as allowing the forces of supply and demand to operate. A multiplicity of prices in the capital market for loans of the same maturity—one for foreign loans, one for domestic commercial bank loans, and one for ‘curb’ or informal loans—suggests that not all prices could possibly have been ‘right’.

In all late-industrializing countries—Japan, Korea, and Taiwan included—not only have governments failed to get relative prices right, they have deliberately got them ‘wrong’, in order to stimulate investment and trade.footnote2 They have subsidized the price of capital and exports. The faster growth of the East Asian countries is therefore attributable less to freer markets than to the institutions that have allowed subsidies to be allocated more effectively than elsewhere. Consequently, an analysis of disparate growth rates among late-industrial izing countries requires an institutional approach.