Seven
Import Restriction and Liberalization

Wontack Hong

1
The "Protectionist," Export-Oriented Economy

Unless exorbitant costs will result from their adoption, economic theory favors general taxes and subsidies over tariff protection. Whatever its objects, tariff protection is bound to generate by-product distortions in factor intensity, in consumption, and toward home-market bias (see Corden, 1971). Furthermore, quantitative restrictions on imports are considered even more distorting than tariff protection.^[1] Despite this knowledge, however, many countries relying on export promotion, such as Korea, have maintained fairly severe import-restraining systems in the form of both tariff protection and quantitative restrictions, partly because of political considerations of vested interest groups (as in the case of agricultural protection) and partly because import restriction is believed by many policymakers regardless of trade theorists' statements to the contrary to be the best available policy measure at an early phase of economic development. Import restriction is thought to Pro-

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mote infant industries (and rapidly convert them into exporters) and also to maximize the foreign sales of currently exporting industries (at the expense of domestic consumers' surplus).^[2]

Countries such as Hong Kong and Singapore have pursued export-oriented growth strategies while maintaining free-trading regimes almost from the beginning. Countries such as Korea, Taiwan, and Japan, on the other hand, maintained fairly protectionist import regimes for long periods of time. It was not until the 1960s that Japan eliminated the bulk of its formal quantitative restrictions: the nominal import liberalization ratio (by items) expanded from less than 70 percent in 1960 to about 93 percent in 1964, and to 97 percent by 1976. Similarly, Taiwan did not eliminate the bulk of its formal quantitative restrictions until the early 1970s: the nominal import-liberalization ratio increased from 61.5 percent in 1970 to 96.5 percent in 1973.^[3] As a result, in both Japan and Taiwan, quantitative import restrictions are now essentially limited to special laws and other invisible unofficial means. Korea is scheduled to eliminate the bulk of its quantitative restrictions during the period of 1984 88.^[4]

This chapter analyzes the efficiency and welfare implications of import restriction and import liberalization in an export-oriented developing economy. In light of the Korean experience, it addresses the

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question of whether extensive import liberalization is always a necessary condition for the successful growth performance of an export-oriented economy. If not, it asks, when does it become a necessary condition?^[5]

In order to give the complete picture, section 2 discusses the unified analytical framework. Section 3 examines the experience of Korea in its early phase of export-oriented growth and analyzes the effect of its import policy on economic growth. Section 4 examines the Korean experience in the later stage of growth, when Korea's comparative advantage started to shift away from the simple labor-intensive consumption goods toward more capital-intensive intermediate and investment goods. The effect of sustained protectionist import policy and the need for more extensive import liberalization are analyzed. Section 5 delineates the liberalization effort of the Korean government during the period 1983 86. Emphasis is given to the politics of protection versus liberalization. The chapter concludes that in order to initiate export-oriented growth, a developing economy must undertake some minimum level of import liberalization, because an extremely protectionist regime would simply frustrate any kind of incentives given to the export sector. However, extensive import liberalization is not a necessary condition for initiating and sustaining successful export-oriented growth. Only at a later stage of development, when the economy starts shifting into the intermediate and investment-goods sectors, might extensive import liberalization become a necessary condition for maintaining production efficiency and maximizing consumer welfare.

2
Analytic Framework

2.1
Earning versus Saving Foreign Exchange:
Export Promotion versus Import Substitution

This section summarizes the analysis of Keesing (1967) and Bhagwati and Krueger (1973). They argue for the promotion of exports (earning foreign exchange) and against the substitution of imports (saving foreign exchange).

First of all, the argument is made that the most important source of economic growth is the upgrading of human resources and production technology rather than the simple accumulation of physical capital. It is

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persuasively argued that under an export-promotion regime, entrepreneurs are mainly concerned with cutting costs, keeping production facilities and techniques up to date, and improving product quality and marketing to suit consumer taste (both at home and abroad), whereas workers are subject to great pressure to perform and train others. Under an import-substitution regime, on the other hand, entrepreneurs presumably spend most of their energy manipulating government officials (who have mastered the finer arts of lobbying, corruption, and graft), in order to improve their protection, while workers learn lackadaisical ways, as they are not pressed to raise their quality and productivity performances. A developing country should therefore gain higher-quality industrial experience and undergo greater pressure for quality and efficiency performance by selling the same value of output abroad under competitive conditions than at home with protection. In short, an export-promotion regime is believed to create human resources more suitable for sustained growth than is an import-substitution regime, which, by encouraging the wrong skills and habits, casts a long shadow over the future of the economy.

It follows, then, that one of the important gains to be made from trade is rapid technical progress arising from innovative imitation. Adam Smith long ago emphasized the "educative effect" of "mutual communication of knowledge of all sorts of improvements which an extensive commerce to all countries naturally, or rather necessarily, carries along with it" (Cannan ed., 1950, 125). Exporting firms must face both price and quality competition in international markets, and consequently the survival and success of each exporter depends on adaptive innovations and active absorption of available production techniques.^[6] The export-promotion strategy also enables an economy to take full advantage of economies of scale. Even when the initial markets are found at home, the physical layout of manufactures permits a ready exploitation of scale economies and an easy transition into export markets.

Both export-promotion and import-substitution regimes may be characterized by a mistrust of laissez-faire and free trade. However,

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foreign governments respond to the extreme abuse of export subsidies not tolerated by international trade conventions. Hence the potential for arbitrary government intervention is more restricted under an export-promotion regime than it is under an import-substitution one. Furthermore, it is believed that in an effort to make local prices and wages appear cheap, less inflationary policies are pursued under export-promotion regimes. This, in turn, restricts the size of subsidies and tax exemptions a country can afford, providing a built-in check on excessive intervention.^[7]

For a developing economy, foreign products may mostly reflect locally unattainable natural resources, skills, and technology. Most likely there will be a lack of substitutability between local resources and foreign-supplied resources. The ability to pay for needed imports may, then, severely limit economic growth. An export-promotion regime is believed to relieve the foreign-exchange constraint on growth more readily than is an import-substitution regime.

Another advantage of export-promotion regimes is that they naturally tend to rapidly expand the volume of exports and consequently also the volume of imports, while import substitution regimes tend to reduce (or increase less rapidly) the volume of a country's trade. According to Corden (1971), the opening up of an economy to trade (which may be measured in terms of the export/GNP ratio) generates a "static" efficiency gain that is very similar to a "once-and-for-all" technical advance that raises the absorption-possibility frontier of a country at a given factor-supply level. Furthermore, with a given constant propensity to save, the static efficiency gain may itself induce the rate of capital accumulation to rise. Consequently, it will raise the growth rate of the economy. This can be described as the "induced-growth gain" from trade. If investment goods are mostly imported, then this induced-growth gain will also include the effect of reduced prices of investment goods. Moreover, it is possible that the opening up of trade (or the rising trade-volume/GNP ratio) will also raise the rate of growth of an economy by directly increasing the country's propensity to save.

2.2
Protection, Offsetting Policy Measures, and Growth

In a typical developing economy, with typical political power balances, import restrictions in the form of both tariffs and quotas have to be accepted as a fact of life. However, as shown by Johnson (1967) and Bhagwati (1968), when industrial promotion and growth are by and large biased in favor of the production of commodities in which the country has a comparative advantage, the adverse efficiency and welfare effects of the protection (which is attuned to the sectors with comparative disadvantage) are alleviated as the economy grows and as policy measures promoting industry are enforced.

Figure 7.1 illustrates such an economy. With free trade the country produces x and y at f . In order to highlight only the aspect of "protection-cum-second-best-policy," we now postulate a small open economy in which all kinds of external economies are completely taken care of by a set of ideal taxes and subsidies. Consequently, the production-possibility curves represent the "true" ones and, in the absence of tariff protection, production and consumption are determined at the welfare-maximizing optimal points.

With a tariff-distorted domestic price ratio p* , however, the country finds itself producing outputs at q , adversely affecting the production of the exportable, y . Consumption is at c where an international price line, p , passing through q intersects the Engel line corresponding to the domestic price ratio p* . Postulating a set of well-behaving homothetic social indifference curves, we have drawn a linear Engel line that represents the income-consumption path corresponding to the given commodity price ratio; bq of y is exported, and bc of x is imported, but an amount equivalent to tc of x is taken away as government tariff revenue. To avoid cluttering the geometry, the diagram omits the social indifference curves, one of which passes through C with a slope equal to that of p* . It is assumed that tariff revenue is not redistributed to the private sector as an income subsidy, but instead is spent by the government.^[8]

When import restrictions are a fact of life, there are always second-best policies to consider: in the presence of irremovable import-substitution-biased commodity-market distortions, a country can adopt certain offsetting policy measures to promote production and exports of the unprotected sector. At the given factor-supply level, and holding

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Fig. 7.1.
Tarriff Protection and Second-Best Policies

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Fig. 7.2.
Tariff Revenue and Aggregate Consumption Pattern
Note: do  represents national product at domestic market prices,  d*o  national product
at factor cost, and dd * the total revenue from tariffs. This represents the case of
balanced trade and no factor payments to other countries. National expenditure and
product are equal in size.

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the distorted domestic price ratio unaltered at p* , the government can try to shift the output pattern in the direction of f by introducing a second-best policy measure such as subsidized credit rationing in favor of y . This will necessarily result in by-product efficiency losses in production, and place the economy inside the given production-possibility curve. In figure 7.1 such a policy leads the output pattern to move alone a path like "Offsetting Distortion' (OD) line I (ODL 1).^[9] This implies that the stronger the offsetting factor-market distortions, the larger the domestic production and exports of y at the expense of x will be.

In a two-factor (capital and labor) framework, we may let y represent the consumption good, which is capital-intensive, and x the agricultural product, which is labor-intensive, completely ignoring the existence of| any other raw materials and intermediate and capital goods. In figure 7.1, a shift in output pattern to a point like q " along the OD line is equivalent (in terms of the increase in output level of y ) to the capital accumulation and growth along the familiar Rybczynski line up to the point q' . The Rybczynski line is the locus of tangencies of the fixed (tariff-distorted) domestic price ratio with the (undrawn) production-possibility curves resulting from successive accumulation of capital. Both movements will imply an increase in real income and a rise in export/ GNP ratio.

As mentioned earlier, such second-best promotion policies will inevitably create efficiency losses. These losses, if large enough, could cause real national income to become smaller than it was in the absence of offsetting intervention even though there may be substantial shifts in the output pattern and an increase in the export/GNP ratio. Offsetting Distortion line 2 (ODL 2) in figure 7.1 shows the immiserizing path of declining real national income.

In a dynamic context, there will be continual increases in factor supplies and technical progress that shift out the production-possibility curve. In figure 7.1 growth (or capital accumulation) is biased in favor of the unprotected export industry and hence is not immiserizing. So long as import-restriction-induced distortions in commodity markets are maintained, the need for continuous policy-induced structural adjustments through offsetting government policy measures,

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though perhaps reduced with growth, will never disappear even in the absence of external economies. The trade triangle may, for instance, shift along the Rybczynski line from the one with the hypotenuse qc to the one with the hypotenuse q'c' , or shift along the ODL 1 from the triangle with the hypotenuse qc to the one with the hypotenuse q'c ". In a real economy, a combination of both movements will be present.

2.3
Protection, Reinforcing Distortion, and Growth

Just as policies favoring the comparatively advantaged (nonprotected) industries can offset some of the adverse effects of protection, this section illustrates how industrial promotion of the protected (comparatively disadvantaged) industries aggravates, or reinforces, these effects.

In figure 7.3 y represents the intermediate and capital goods sector, which is capital-intensive, and x represents the consumer goods sector, which is labor-intensive. Output and consumption are at q and c , respectively, with tariff protection of the now import-competing y sector. Tariff revenue is equivalent to ct of y . Since the international price line p has been drawn steeper than the Rybczynski line, capital accumulation results in immiserization. We further postulate that the government promotes the import-competing y sector by, say, maintaining a creditrationing system. The capital-intensive sector is now not only protected by tariffs, but is also promoted by other policy measures. Hence figure 7.3 presents the case in which the government nontariff policy measure induces the immiserizing structural adjustments along RDL (the Reinforcing Distortion line). In the growth process, the nontariff policy measures will reinforce the decline y imports and also the immiserization. Evidence suggests that aspects of immiserizing growth did exist in Korea, especially in the late 1970s, that were serious enough to substantially reduce the allocative efficiency of the economy.

2.4
Protection of Monopolistic Export Industries

In figure 7.3 growth by capital accumulation will (with or without the reinforcing distortions) eventually lead the output point to reach the Engel line, beyond which y becomes exported. With a perfectly competitive market structure, protection of the y sector beyond the Engel line is meaningless. However, Robinson (1969) shows that when the export sector consists of a monopolistic producer, import restriction of export goods can have the effect of expanding the proportion of export sales to total sales (at the expense of consumers' surplus) without resulting in allocative inefficiency. Monopolistic profit maximization through

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Fig. 7.3.
Immiserizing Growth

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price discrimination in the domestic market does not cause the total output of the good to differ from that of free trade; it only expands the proportion of the export sales out of a given quantity of total output. That is, protection of the monopolistic export sector raises the export/ GNP ratio, results in a redistribution of income in favor of the monopolist and against the domestic consumer, and may even cause a premature exportation of the import good, but it does not affect allocative efficiency.

3
Protection and Liberalization in the Early Phase of Korea's Growth

3.1
1961 67:
Import Liberalization and an Export-Promotion Regime

As a result of the heavy bias toward import substitution in the 1950s, Korea's commodity markets were significantly distorted. As a result, the labor-abundant Korean economy had not actively taken advantage of the gains to be made from trade a la Hecksher-Ohlin, and maintained an only half-open economy. With the initiation of the export-promotion strategy in 1961, the Korean government replaced its multiple exchange-rate system with a unitary one, made a series of exchange-rate adjustments to rectify the extremely overvalued domestic currency, and above all tried to prevent the direct impact of its own extremely protectionist import-restriction regime from negating the newly created incentives for export activities.^[10]

Four principal policy measures were adopted in Korea in order to pursue this new export-oriented growth strategy: vigorous administrative support for export promotion, a preferential tax system, a subsidy allocation for export activities, and, finally, a reduction of the import-substitution biases of the economy. This last was especially important, because extreme import restrictions may well more than offset any kind of incentives given to export activities. For example, both tariffs and quotas are equivalent to taxes on imports, which, in turn, can become taxes on exports. Also, when direct import restraints are used as the instrument for correcting balance-of-payments deficits, exports will suffer the exchange rate will be overvalued, and hence the competitive power of the export industries will be reduced.

In other words, a country cannot launch an export-promotion strategy while maintaining extreme forms of import restriction. Thus,

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when it was decided that this was the policy to be followed, the Korean government had to free export producers from the negative effects of tariff protection and quantitative restraints at the outset, by allowing tariff-exempt imports of the raw materials and investment goods that were directly used in the export-production process. Furthermore, the government tried to reduce the general level of quantitative import restrictions, culminating in the introduction of the negative list system in the second half of 1967.

In the period 1961 63, the number of items positively listed as importables (subject to government import licensing, quotas, foreign-exchange allocation ceilings, linkages to exports, and other regulations) fluctuated in the range of 1,000 to 1,600. Feeling the pressure of balance-of-payments deficits, the government reduced the number of importable items to fewer than 500 in late 1964, but then restored the 1961 63 level in 1965; the number of importable items was increased from 1,778 to 2,491 in 1966, and 3,852 by July 1967, when the switch to the negative list system occurred. Now just the "prohibited" or "restricted" import items were recorded.

Under the negative list system, only a handful of the manufactured goods belonging to SITC (Standard International Trade Classification) code numbers 6 and 8, as well as certain food products, got classified as "Automatic Approval" import items. Most finished consumption goods were either classified as "Restricted Import" items or as "Prohibited Import" items.^[11] The government effectively controlled the import of these restricted items by imposing annual import ceilings. Furthermore, there were numerous special laws for selected industries that, purely incidentally or with expressly protectionist intentions, restricted the import of related "automatically approved" commodities. In principle, restricted imports that competed with domestic production were allowed only to fill the estimated gap between domestic supply and demand. Quantitative import controls of noncompetitive raw materials and intermediate and capital goods (which were classified as restricted items and were not directly related to export activities) seem to have been influenced entirely by the overall balance-of-payments situation.

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Imports of raw materials and intermediate inputs and investment goods for foreign exchange-earning activities, on the other hand, were approved automatically, irrespective of their classification.^[12] Furthermore, imports financed by government-contracted foreign loans were permitted after consultation with the Trade Committee, irrespective of classification.^[13] All in all, according to Frank, Kim, and Westphal (1975, 58), out of 30,000 SITC commodities, the number of "automatic approval" items expanded from 2,760 in the first half of 1967 to 17,128 in the second half, while the number of "prohibited import" items was reduced from 26,148 to 2,617.^[14]

Since the old system of commodity classification (used prior to the second half of 1967) was significantly different from the more systematic classification (into 30,000 items based on the UN's SITC manual), these numbers can only serve as a crude first approximation of the degree of liberalization. Nonetheless, we still conclude that the minimum requirements of import liberalization were satisfied in Korea, and that the remaining import-substitution biases could have been more than offset in the 1960s and 1970s by various policy measures to promote exports of manufactures.

3.2
1967 78:
Protectionist Regime

This section gives a rough description of Korea's protectionist regime during the period 1967 78, and shows that little progress in import liberalization was made after 1967.

Following the introduction of the negative list system, the average basic legal tariff rate (weighted by import value of each commodity) was raised from about 17 percent in 1963 67 to about 26 percent in 1968  72. From 1964 to 1972 there was also a special tariff law that empowered the Ministry of Finance to collect additional special tariffs (up to 90 percent of the differential between the estimated wholesale value and the import cost) on nonessential imports.^[15]

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It was only after the 1973 tariff reform (which abolished the special tariff system) that the tariff rate was reduced to a 20 percent level (the average legal tariff rate for all commodities amounted to 20 percent in 1973 74 and 1976) and to 19 percent in 1978.^[16] However, because of the tariff exemptions or reductions that were granted on the imports of raw materials directly used for export production and on the capital goods imported for foreign direct investment projects, export production, and other important industries, the actual tariff rate (the amount of tariff revenue collected divided by the total c.i.f. value of imports) amounted to only about 9 percent on average during 1962 71, and about 7 percent throughout the period 1972 83.^[17] The average tariff rate actually collected, then, does not seem to have been extremely high in Korea but since those tariffs collected were mostly from the commodities whose imports were "approved," they do not tell the magnitude of the import premium, or the effective rates of protection, generated by the quota system (see tables 7.1 and 7.2).

When the government changed from the positive list of quantitative restrictions to the negative list system in 1967, the nominal import liberalization ratio by item (on the basis of 1,312 SITC 5-digit classification) amounted to nearly 60 percent. However, as mentioned above, there was no further movement toward liberalization after 1967, and in fact the import-liberalization ratio rather steadily declined thereafter to become about 50 percent by the first half of 1978. According to table 7.3, the number of restricted import items, as well as their share in total value of imports, was substantially larger in 1978 than it had been in 1967. There were significant increases in import restrictions (both in terms of number of items and value of imports) of machinery, chemicals, and other manufactures (except textiles) during 1967 78. Even raw materials were subject to increased import restrictions. It was only after the

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second half of 1978 that the import-liberalization ratio (both by items and by value) began to increase.

Between 1970 and 1975, out of Korea's total commodity imports the share of consumption goods amounted to only about 5 percent. The share of foodstuffs amounted to about 16.6 percent in 1970 and 14.3 percent in 1975. Consequently, about 80 percent of Korea's imports during this period consisted of raw materials, intermediate-input materials, and capital goods.^[18] On the basis of this observed composition of trade, Korea's protectionist regime may be characterized as follows: imports of agricultural products were restrained to the minimum necessary levels, while preferential treatment was given to the import of capital goods (in order to accelerate investment activities) and to raw materials and intermediate goods (in order to raise the utilization rate of existing production capacity). As a result, at least until the mid 1970s, the quantitative import restrictions were essentially set against agricultural products and finished consumption goods. This is important; it means that the import restrictions did not directly affect the production of other (export) goods.

3.3
Growth Performance of the Korean Economy

In the 1950s Korea's imports were mostly financed by foreign grants-in-aid. The opening up of the Korean economy to trade (through the switch to an export-oriented growth strategy) occurred over an extended period of time, spanning the 1960s and 1970s. The efficiency gains from this action materialized in the form of both rapidly increasing real wage rates and rising rates of return on investment. The average gross rates of return on investment in the Korean manufacturing sector increased from about 12 percent in 1954 61 to about 23 percent in 1972 79 (see table 7.4). Over the period 1962 79, there were also rapid increases in domestic savings, which, together with the productivity gains from trade, allowed nearly 10 percent average annual growth rates of GNP. The average annual growth rate of GNP rose from about 4 percent in 1953 61 to about 8 percent in 1962 66 and to almost 10 percent in 1967 79 (see table 7.5).

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During the 1953 61 period of import substitution, Korea was insignificant as an exporter of primary products, and the export/GNP ratio amounted to only about 0.01. By pursuing the export-promotion strategy, Korea became an exporter of manufactures, and the export/GNP ratio rose rapidly from about 0.04 in 1962 66 to about 0.26 in 1977 79. Commodity exports expanded from a mere $33 million in 1960 to about $15 billion in 1979, and the proportion of manufactures out of total commodity exports increased from about 15 percent in 1960 to more than 90 percent by 1979.

As the case of Korea proves, an export-oriented economy can achieve both high growth performance in output and export expansion with just a minimum (but necessary) degree of import liberalization. Obviously, the fairly extensive quota and tariff systems that Korea maintained throughout the period 1967 79 did not prevent it from achieving high rates of growth in either of these areas. Hence it is fair to say that the export-promotion policy measures more than offset any possible adverse effects from the tariffs and quotas. In fact, the system of tariff protection may even have contributed positively to Korea's growth. Real GNP grew about 9 percent per annum during 1962 84, and domestic savings expanded from about 4 percent of GNP in 1953 61 to about 25 percent in 1976 85. Government saving was negative prior to 1964, and negligible in 1964 66. However, it amounted to an average of about 5.5 percent of GNP during 1967 85, and about 40 percent of this was financed by tariff revenue in spite of the fact that the actual rate of tariffs was reduced from about 9.1 percent in 1967 71 to about 6.2 percent in 1980 85. Because the Korean government has been directly involved in various productive investment activities, the static negative effects of the tariff system have to be weighed against its positive contributions of reducing consumption, enhancing domestic savings, and increasing productive investment. (This possibility has been indicated in figure 7.2.)

Owing to the fact that prior to the mid 1970s imports of intermediate and capital goods were subject to less severe quantitative controls than were consumption goods, import substitution of these products had not been as profitable as it had been for consumption goods, and hence was relatively slow. It might sound paradoxical, but Korea's early failure to extensively promote the intermediate and capital-goods industries seems to have contributed positively to rapid export expansion. That is, manufacturers of export goods were relatively free to use low-cost imported intermediate and capital goods rather than having to use high-cost domestic products even when these products were classified as

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restricted import items. This factor, combined with the low cost of labor, seems to have helped Korea achieve an extremely rapid export expansion.

4
Protectionist Policies in the Later Stages of Growth

4.1
The Mid 1970s:
Protection of Intermediate and Investment Goods Sectors

As noted, until the mid 1970s, both Korea's industrial production and its exports were dominated by final-consumption goods, whose production was labor intensive and depended heavily on imported intermediate and investment goods. Import restrictions were mostly on consumption goods, at the expense of Korean consumers. This apparently was not fatal to the growth performance of the economy. However, with the beginning of the third five-year economic development plan (1972 76), the Korean government began to promote "heavy and chemical" industries, and actually implemented various tax-cum-financial incentives for these industries^[19] (see Hong 1979, chap. 4). As a result, there was extensive domestic production of hitherto imported intermediate and investment goods by the late 1970s. Unfortunatey, many of the so-called heavy and chemical industries promoted by the government were excessively capital-intensive, and Korea did not have the comparative advantage necessary to successfully compete against foreign products. As a result, promotion came to imply somewhat extensive import restrictions on these capital-intensive intermediate and investment goods, and both the growth rate of exports and of GNP would be affected

As early as 1972 when the first petrochemical factories began operation, MTI changed ten petrochemical products from "automatically approved" to "restricted import" items. Such practices intensified and became more frequent in the late 1970s. Since 1976 those wishing to import machinery worth more $1 million, and financed either by foreign loans or foreign-currency loans from domestic banks have had to report in advance to MTI (and after 1985 to the Korea Machine Industry Promotion Association). As a condition for approving the import of the domestically unproducible portion of the machinery, MTI specified

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a certain portion that must be produced domestically. MTI also specified the required domestic-content ratios for selected plant facilities that cost more than $3 million and were financed by foreign loans or foreign-currency loans.^[20]

According to table 7.3, the proportion of restricted import items in the machinery sector (in value terms) amounted to about 46 percent of total machinery imports in 1967, rising to about 79 percent in 1978, and to 80 percent in 1981. In the chemicals sector, the share of restricted items increased from about 23 percent in 1967 to about 60 percent in 1978, and was 58 percent in 1981. As shown in table 7.6 chemicals imports have been restricted mostly by special laws rather than by MTI classification notices.

4.2
Impact on Export Production and Trade Pattern

The Korean government's decision to change its emphasis and promote the "infant" intermediate and investment-goods industries was not simply for the sake of self-sufficiency in these sectors, but also so that they would eventually become the new generation of leading exports. The government believed that tariff protection and quantitative restraints were indispensable policy measures for initiating the domestic production of these products. Unfortunately, such policies could not help but generate the familiar efficiency-reducing effects associated with import substitution, and they immediately affected the production costs of related downstream domestic industries. Eventually, the adverse effects were passed on to export-production activities. Unlike in the earlier period, this time government promotion activities did not offset the efficiency losses of protection, but rather encouraged them.

Until early 1971 any intermediate input that was needed for export production could be freely imported, even if it were classified as a restricted import item. However, in October 1971 MTI made 41 intermediate input materials for export production (including even important textile fibers) subject to pre-import approval. In 1975, 12 more items were added to the list, and by 1982, 61 intermediate input items (based on the 4-digit CCCN classification) were subject to the prior-to-import approval system. Moreover, the import of selected plant facilities for eight industries was completely prohibited, even when they were to be

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used for export production. In 1985, 54 intermediate input materials for export production were subject to the requirement of a prior recommendation. Among them, about 20 items (mostly petrochemical products) could obtain the recommendation when domestic supply prices exceeded c.i.f. import prices by more than 3 to 10 percent.

By 1974 the tariff exemption on capital equipment for export production had also been changed to tariff "payments on an installment basis," and in 1975 the tariff exemption on raw material imports for export production was changed to a "tariff drawback" or refund, after making initial payments to the government. In late 1977 the Korean government introduced the "limited tariff drawback" system on materials imported for export production. Out of the 117 items subject to this system, 87 were given zero percent drawback (no tariff exemption at all) and the other 30 were allowed between 2 and 97 percent drawbacks of the tariffs that been paid at the time of customs clearance.^[21]

The number of items subject to the limited tariff drawback system was reduced to 62 in early 1980, and then expanded to 128 by mid 1981, to 212 by early 1982, and to 266 by mid 1983.^[22] By the end of 1984, 170 items were subject to zero percent drawback, and 84 items were subject to between 2 and 90 percent drawback. In principle, the tariff drawbacks on these items are allowed only on the portion that cannot be satisfied by domestic supply, regardless of domestic price. This has generated continuous conflicts between the users (export producers) and the suppliers (domestic import-competing producers) of the specific intermediate inputs.

According to Young et al. (1982, 49), in 1978 the average effective rate of protection for heavy and chemical industries amounted to 71.2 percent, while that for light industries amounted to - 2.3 percent. According to the input-output table data, the share of raw materials (excluding crude oil) in Korea's total commodity imports increased from 9.4 percent in 1975 to 11.3 percent in 1980, but the share of intermediate-input materials decreased from about 32 percent in 1975 to about 29 percent in 1980. Presumably, the protection and promotion of heavy and chemical industries was responsible for the declining share of intermediate-input materials in Korea's total commodity imports.

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The labor-intensive consumption-goods sector had dominated Korea's commodity exports in the early phase of export-oriented growth. By the late 1970s, however, a new group of leading exports (including machinery, transport equipment, and iron and steel products) had emerged. These belonged to relatively capital-intensive sectors, making Korea's overall commodity composition of exports shift toward a more capital-intensive one. Hong (1987) shows that the value of capital per worker directly and indirectly employed in the Korean manufacturing sector for the production of commodity exports rose from $3,000 in 1966 to $8,900 in 1980 (in constant 1980 dollar prices). At the same time, owing to the promotion of capital-intensive import-substituting sectors (that included various petrochemical products), the value of capital per worker that was employed in replacing competitive imports rose from $4,800 in 1966 to $12,200 in 1980. The average capital intensity of Korea's manufacturing sector itself rose from $3,800 in 1966 to $10, 400 in 1980.

With capital accumulation in a country, one naturally expects to observe a rising wage/rental ratio, and a rising capital/labor ratio in both production and exports. Unfortunately in Korea many of those intermediate and investment-goods sectors promoted by the government in the 1970s turned out to be excessively capital-intensive (for that particular stage of growth), and these sectors ended up having to be protected by tariff and quotas, which in turn raised the production costs of downstream industries.

During the period 1965 76, Korea had maintained an average annual growth rate of real exports as high as about 34 percent. However, the growth rate of real exports started to decline in 1977, making the average growth rate of real exports only 12 percent per annum for the period 1977 85.^[23] Furthermore, Korea's performance in GNP growth began to look less impressive after 1980. The growth rate of GNP fell from nearly 10 percent per annum on average in 1967 79 to around 7.5 percent in 1981 85. The significantly reduced rates of export expansion and GNP growth may at least partly be related to tariff protection and quantitative restrictions. Consequently pressure arose for the government to search for more efficient policy measures with which to promote the intermediate and investment-goods sectors.

4.3
The Late 1970s:
Abortive Import-Liberalization Attempts

In an early stage of export-promotion-based development, complete import liberalization is obviously not a necessary condition for successful growth performance. In the later stages of export-oriented development, however, an extensive import liberalization may become a necessary condition, not only for maximization of hitherto much neglected consumer welfare,^[24] but also for efficiency maximization. Efficient domestic production is clearly important if exports are to be internationally competitive. Indeed, in Korea, by the end of 1970s nationwide pressure to initiate further import liberalization seems to have appeared.

In 1977 Korea's current account of the balance of payments registered a small surplus for the first time since 1966. This was followed by an import-liberalization effort. In February 1978 the Korean government established the Committee for Import Liberalization to formulate the direction of liberalization and then to determine the items to be liberalized. The import-liberalization ratio by item jumped from about 54 percent in the first half of 1978 to about 65 percent in the second half.^[25] However, MTI seems to have assumed the task of import liberalization in 1978 with reluctance and skepticism.

According to MTI, the items to be liberalized were those that did not compete with domestic production, those for which there were no plans for domestic production, and those that already enjoyed strong international competitive power. The items not to be liberalized were those produced by heavy and chemical industries and other strategically promoted industries, those produced by small- and medium-sized industries, those produced by infant industries that still had to expand further in order to enjoy scale economies, those produced by industries that had substantial forward and backward linkage effects, those produced by industries that supplied necessary intermediate inputs and basic materials to the heavy and chemical industries, agricultural products, and

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luxury goods.^[26] In other words, MTI wanted to liberalize the import of only those items that would have minimal impact on the domestic economy. The number of restricted import items did substantially decrease in the second half of 1978, but most of the newly import-liberalized items were either economically unimportant ones or were classified as "import surveillance" items that could be reclassified as "restricted" should a surge of imports follow.^[27] When the balance on the current account deteriorated seriously in 1979, the halfhearted liberalization movement was brought to a halt in 1980.

5
Import Liberalization in the 1980s

5.1
The Protectionist Regime as of the Early 1980s

During the second half of 1981 and the first half of 1982, the import-liberalization ratio by item (or the share of automatically approved items in the 7,915 8-digit level CCCN classification) amounted to about 75 percent. However, if those items whose imports were subject to special laws are excluded, then the import-liberalization ratio amounted to only about 55 percent (see table 7.2). In value terms, as estimated by Luedde-Neurath (1984, chap. 8), the import-liberalization ratio for the first half of 1982 amounted to 58.7 percent (not taking into account the special laws), and to only about 22.7 percent if imports subject to special laws are excluded. Since many of the special laws controlled imports of related commodities purely incidentally, and since many of the import items that were only partly controlled were counted as full "restricted import" items, these figures may represent a significant underestimation of the actual degree of import liberalization in Korea in the early 1980s.

A study by Kim and Hong (1982) shows that there were steady decreases in the effective rate of protection for the manufacturing sector as a whole throughout 1963 78. During the first half of the period (1963 70), the decreases in the effective rates of protection occurred most drastically in the export sectors, while the rates of protection for import-competing sectors rather significantly increased. During the period 1970 78, however, the drastic decreases in effective rates of protection occurred in import-competing sectors and in sectors that both ex-

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ported and imported, while there was a significant increase in nominal, as well as effective, rates of protection for export (manufacturing) sectors (see table 7.1). The implications of this somewhat paradoxical phenomenon were examined in section 2. As of 1983 only 38.9 percent of Korea's major export commodities were classified as "automatic approval" items, but the average liberalization ratio by item reached 80.4 percent.^[28]

5.2
Impart Liberalization as a Long-Term Policy Goal

The liberalization movement that was halted in 1980 was resumed in 1981 despite the enormous current account deficit, but was again halted in 1982. The current account situation substantially improved in 1983, and a renewed movement toward import liberalization followed. This time, however, it was approached as a long-term policy goal with a definite annual liberalization timetable. According to the schedule, Korea will reach the OECD level of import liberalization by 1988.

The simple arithmetic average tariff rate was reduced from about 36 percent in 1977 78 to about 25 percent in 1979 81. The weighted average tariff rate also fell steadily from about 19 percent in 1978 to about 12 percent in 1981. In early 1983 the Ministry of Finance (MOF) took decisive initiative in the import-liberalization movement and presented a long-term (1983 88) tariff reduction scheme: the simple arithmetic average tariff rate was scheduled to fall from 23.7 percent in 1982 to 20.6 in 1984 and to 16.9 percent in 1988.

Following the MOF initiative, MTI presented its own schedule of import liberalization: the share of "automatic approval" items was to increase from 76.6 percent in 1982 to 80.4 percent in 1983, to 91.6 percent in 1986 and 95.2 percent in 1988. MTI also presented a list of the "restricted import" items that would be liberalized during 1984 86.

Theory suggests that it is desirable to eliminate quantitative restrictions first, even if this means raising the rate of tariff protection. Since MOF took the initiative, MTI had to follow, and faced the difficult task of selecting a large number of new automatically approved items all at once. Many of the items produced by politically influential monopolistic firms escaped the early round of liberalization, and most of the items scheduled to be liberalized first were produced bv less influential small firms. The former included many heavy industrial and chemical products, and the latter included many finished consumption goods. Owing to the existing political power balances, the consumers' surplus problem

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was, quite unintentionally, significantly taken care of in the early phase of import liberalization.^[29] Furthermore, the government officials seem to have pursued import liberalization indiscriminately, with no clear idea of priority between consumers' surplus and efficiency enhancement at the beginning stage.

5.3
Progress in Import Liberalization

In accordance with MTI's long-term import liberalization schedule, out of the total importable items the proportion of restricted imports declined from about 25 percent to about 12 percent during 1981 85, and the proportion of "special law" items declined from about 19 percent to about 16.6 percent. According to the 1982 Luedde-Neurath data and the table 7.6 data of 1984, the import-liberalization ratio by value (the share of commodities imported as "automatic approval" items out of the total value of commodity imports) increased from about 59 percent to 78 percent during 1982 84 without taking into account special laws, and increased from about 23 percent to about 40 percent excluding the special law items.

Among primary products, imports of raw foodstuffs and mineral fuels were mostly subject to special laws. Among manufactures, the import of chemicals was largely subject to special laws. Not only did the absolute number of restricted items in the chemicals sector decrease in 1981 85, but the proportion of chemical imports subject 10 special laws also declined (from about 60 percent to 47 percent of total importable items). In the case of machinery and other manufactures (SITC 6, 7, and 8, excluding textiles and electronics products), the number of restricted import items has substantially decreased, but the proportion of imports subject to special laws has significantly increased.^[30] Apparently, in cer-

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tain sectors there has been a tendency to replace a "restricted" classification with special laws.^[31] On the whole, however, not only did the number of restricted import items decline significantly during 1981 85, but the proportion of items subject to special laws did too (see table 7.7).

As of 1984, imports of electronics and telecommunication equipment, road vehicles, ships, and other machinery and equipment were heavily restricted. In value terms, nonferrous metal products were also significantly restricted (see table 7.6). However, if we examine table 7.3, we can see that imports of textiles have been steadily liberalized since 1967. Import restrictions on raw materials and iron and steel products very much expanded during 1967 78, but then were substantially liberalized after 1978. About 46.5 percent of raw materials were classified as restricted import items in 1978, but this has been reduced to about 10.4 percent by 1984. As of 1978, about 75 percent of iron and steel products were subject to import restriction in the form of a restricted-import classification, and more than 90 percent of total iron and steel imports were imported subject to some restriction. By 1984, however, less than 10 percent of iron and steel product imports (either by item or by value) were subject to restriction either in the form of restricted-import classification or special laws. Furthermore, as the growth rate of commodity exports slowed down in 1985, the government reduced the number of items subject to the limited tariff drawback system from 254 to 79.

In 1983 the simple arithmetic average tariff rates for raw materials, intermediate inputs, and finished goods were 11.9 percent, 21.5 percent, and 26.4 percent respectively.^[32] By this time, increasingly fierce resistance to import liberalization by the big monopolistic business groups could be detected. The following guiding principles on import liberalization set out by MTI in 1984 reflect this reality:

[Monopolistically produced] commodities will be subject to early liberalization in principle. Although import liberalization should lead to increased competition among firms, it should not be pursued to such an extent as to bankrupt firms. The import liberalization program should also allow for preservation of basic material industries even if they are not