North American Free Trade Agreement

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Industrial policies

 The industrial structure in Korea reflects the country’s poor resource endowment and outward-oriented development strategies (Song, 2004). The government’s intervention in the industrial sector has enormously influenced the development and organization of industries and firms (Jwa, 2001). The government has initiated almost every major investment in the private sector. During 1962-1981, the government introduced many industrial incentives to promote exports (Das, 1992). The primary emphasis of South Korea’s industrial policy since the 1960s has been to promote exports. The government promoted light industries like textiles and footwear for export during the first two Five-Year Plans. In the 1970s, Korea’s industrial policy aggressively promoted heavy and chemical industries (HCI). Excessive expansion in HCI, combined with two oil shocks in 1973 and 1979, resulted in high inflation. The inflation rate shot up to more than 20 percent during the 1970s. The policies of the 1980s focused on controlling inflation and stabilizing prices. In addition to anti-inflationary policies, various other policies were undertaken that reduced the degree of government intervention in resource allocation in the 1980s and 1990s (Jwa). The industrial policies of the 1990s also emphasized deregulation. Under the policies during the past four decades, the industrial structure of Korea was transformed from being traditionally labor-intensive to capital-intensive to technology-intensive (Song). Public enterprises (PEs) have played a crucial role in Korea’s economic development. With the expansion of HCI, investment in PEs accelerated from 1972 to 1981. The government’s PE policy in the 1960s and 1970s encouraged PEs in any area of industry considered essential for the export growth of Korea and deemed unable to be handled efficiently by private enterprise; however, PEs declined in importance with the implementation of the privatization policy in the fifth Five-Year Plan (1982-86). The government attempted to privatize as many PEs as possible in the 1980s (Song, 2004). As part of new reforms of the late 1990s, privatization of government-owned enterprises was emphasized. The main objectives of the privatization program have been to improve the efficiency of enterprises and attract foreign capital. Eight out of 24 major state-owned enterprises were privatized between 1998 and 2002 (Yang, 2004). The government’s policy of encouraging fast-growing firms through credit and tax benefits and the promotion of HCI in the 1970s resulted in increased industrial concentration and the growth of chaebol (or jaebol) (Song, 2004). Chaebol are large family-based industrial conglomerates. The government directed massive resources into the chaebol to carry out highpriority investment projects as they were regarded as companies that could achieve economies of scale and compete in international markets (Kwon & Suh, 2003). According to Jwa (2001), the growth and political power of the chaebol have influenced the majority of Korea’s industrial policies since the 1970s. The intervention of the chaebol into industrial policies contributed to the aforementioned financial crisis in 1997. The Korean government controlled the country’s financial system and directed resources to support chaebol firms, which ended up with high debt to equity ratios (Jwa). The average debt to equity ratio of the top 30 chaebol increased to 519 percent in 1997 from 347.5 percent in 1995 (Kwon & Suh). In 1998, the Korean government introduced the Five-Point Accord program to restructure the corporate sector. The reforms in this program involved improving corporate governance, reducing debt to equity ratios, empowering minority shareholders, and corporate downsizing (Emery, 2001). As of 2001, the top 30 chaebol comprised 624 companies and contributed 13 percent of Korea’s GNP (Song).

Exchange rate policies

 From 1964 to 1980, South Korea followed a single-currency peg system by pegging the won to the U.S. dollar. In 1980, Korea adopted a multiple-currency basket peg system with the effective exchange rate linked to a basket of currencies of South Korea’s major trading partners – the U.S, Japan, Germany, and Canada. In 1990, South Korea considerably liberalized its exchange rate system and replaced the pegged exchange rate system with a market-average exchange rate system (Jwa, 2001). The Korean won continually depreciated against the U.S. dollar in nominal terms during the early 1990s, increasing the competitiveness of Korean exports (Harvie & Lee, 2003); however, when the won appreciated against the U.S. dollar and the Japanese yen in the mid-1990s, Korea witnessed a reduction in export demand and loss of international competitiveness. With the onset of the financial crisis in 1997, the nominal value of the won relative to the U.S. dollar declined dramatically by 91 percent (Harvie & Lee). South Korea adopted a free-floating exchange rate system in 1997 in response to the financial crisis (Jwa).

Trade and macroeconomic policies 

Prior to the implementation of the first Five-Year Plan in 1962, Korea’s economic policies centered on import substitution supported by an overvalued exchange rate and heavy reliance on foreign assistance. Since the early 1960s, however, Korea has followed an outwardoriented growth strategy with strong promotion of exports (Song, 2004). The government of Korea has introduced many export incentives like tax deductions, wastage allowances, tariff exemptions, preferential loans, and automatic approval of loans by commercial banks to firms with export letters of credit (Lim, 2003). During 1961-1972, the government exempted exporting firms from indirect taxes, that is, taxes on income earned from export sales, and provided a 50percent exemption from corporate and personal income tax on export earnings (Song). Those policies and others reflect South Korea’s long-standing practice of formulating trade policies in a manner that supports its industries and corporations (Jwa, 2001). According to Jwa, the importing of foreign products into Korea is impossible if similar products are produced domestically; however, a firm may be exempted from this rule if it requires imported inputs for producing export goods. The Ministry of Trade and Industry established general trading companies (GTCs) in 1975 to speed up export expansion. The original requirements for a company to be designated a GTC were that its paid-in capital was at least approximately US$2.1 million, its annual exports were at least US$50 million, it had at least 10 overseas branch offices, and it offered public stock. Since 1975, the Korean government has continuously pressured the GTCs to expand exports by regularly raising the minimum export value requirement. The annual export value criterion for GTC designation was raised from US$50 million in 1975 to 2 percent of total Korean exports by the 1990s. The government has provided the GTCs with various export incentives, including cash subsidies tied to export volumes (Song, 2004). Korean exports increased from US$55 million in the early 1960s to US$193.8 billion in 2003 (Export-Import Bank of Korea, 2005). Korean manufacturers rely heavily on imported raw materials and machinery. Korea’s imports increased to US$178.8 billion in 2003 from US$390 million in 1962 (Export-Import Bank of Korea). South Korea has experienced changes in its political system over the past four decades, and with those changes, it has altered its policies on foreign direct investment (FDI) in several major ways. Korea allowed no FDI in the 1950s, but the policy changed in 1962 with the implementation of the Foreign Capital Inducement Act. Until the 1980s, South Korea relied heavily on foreign borrowing and maintained a restrictive policy on foreign investment. The FDI policies were eased in the mid-1980s by allowing foreign investment in many sectors (Yeo, Yoon, & Wong, 2004). The policies on foreign investment were further liberalized in the late 1990s in response to the financial crisis. By 2003, South Korea had opened almost all areas of the economy to foreign investment except national security and cultural sectors. The cumulative FDI inflows for the period 1962-2002 stood at US$78 billion, of which US$53 billion entered Korea during 1998-2002 (Yeo, Yoon, & Wong) Since the early 1960s, the Korean government has allocated financial resources strategically to select sectors or industries by controlling the financial sector, particularly banking. The government has attempted to liberalize the financial sector since the 1980s, but the intertwined internal structural problems of the government and the financial and corporate sectors made the economy fragile to external shocks and contributed to financial crisis in 1997. In response to the financial crisis of the late 1990s, many new reforms were adopted to strengthen the financial system. The new reforms have required any financial institution whose assets exceeded a certain level to set up a compliance officer and audit committee to help improve transparency in its financial system. As part of the new reforms, the Financial Supervisory Service (FSS) was established in 1999. The main purpose of the FSS is to supervise and examine the whole financial sector, including the banking and security, insurance, and other non-banking industries. By the end of 2000, major creditor banks and business groups had reached an agreement to reduce their debt to equity ratios below a 200-percent ceiling as part of their capital-structure improvement. In 2001, a Continuous Assessment System of Corporate Credit Risk was introduced. Under this system, the main creditor bank selects companies semiannually to assess their credit risk for symptoms of insolvency (Oh, 2004). The restructuring of the financial sector as part of the new reforms resulted in a large fiscal deficit of 4.2 percent of GDP in 1998. As a result of the government’s tight fiscal policy, combined with high tax revenues in 2000 and reduced payments to unemployed workers as the employment rate rose, the fiscal deficit fell to 1.3 percent of GDP in 2000.

Textile and apparel sectors and related policies

The textile and apparel industry is a leading industry in South Korea, contributing 14 percent of industrial employment in 2001 (Hoon, 2002). During the first and second Five-Year Plans, this industry emerged as one of the main manufacturing industries experiencing growth and was considered a growth engine for the whole economy. In the early 1960s, government policies provided this industry with export incentives, such as free access to imported inputs, concessions on tariffs and indirect taxes, and credit preferences (Westphal, 1979). In the 1970s, textile and apparel exports accounted for 30 percent of Korea’s total exports (Kim, 1992); however, the share of these products in total exports fell to less than 20 percent by 2002 with the shift in manufacturing emphasis to electronics and technology production (Kim, 2004). Today, the most significant textile exports of South Korea are fabrics, finished goods, raw materials, and yarns. The major textile imports are finished products, raw materials, yarns, and fabrics (Stylios, Kindness, Stephenson, Burek, Emden, & McCarthy, 2004). The Korean government has promoted and encouraged foreign investment in the synthetic fiber and fabric industries since the 1960s. The synthetic fiber and fabric industries have been supported through the chaebol. Between 1970 and 1980, South Korea went from dependence on synthetic-fiber imports to self-sufficiency and exportation of these fibers.

1. Introduction
1.1 Background
1.2 The Problem
1.3 Justification
1.4 Research Objective
2. Literature Review
2.1 India
2.2 South Korea
2.3 The Asian Financial Crisis
2.4 North American Free Trade Agreement
3. Setting of the Research Problem
3.1 Research purpose and Objective
3.2 Theoretical Framework
4. Research Procedure
4.1 Models
4.2 Operational Definitions and Data Sources
4.3 Statistical Analysis
4.4 Preliminary Analysis of Multicollinearity
4.5 Test of Heteroscedasticity
5. Results and Discussion               
5.1 Results of Gross Textile Exports
5.2 Results of Gross Apparel Exports
5.3 Results of Net Textile Exports
6. Summary, Conclusions, Implications, and Suggestions for Future Research
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Textile and Apparel Exports of India and South Korea,1974-2001: An Econometric Analysis