Why are some developmental states more effective than others? The case of South Korea and Indonesia

• Grace Avila Casanova
• 8. April 2019

Prior to the publication of The East Asian Miracle (1993), a World Bank report on development outcomes, South-East Asian countries such as Malaysia, Indonesia and Thailand had already been predicted to converge with their industrially successful counterparts: Taiwan, Japan and South Korea (Korea hereafter). In the light of developmental states (DS), Indonesia and Korea are particularly compelling cases because despite having started off similarly, their economies show contrasting realities today. The undeniable emergence of one state ahead of the other leads to a number of questions on how these countries approached development. This article attempts to give answers by exploring the literature on DS as a historical phenomenon.

Development statism draws upon the role of States in industrialisation; structures and leadership. The term ‘capitalist developmental state’, often used to explain Japanese success, outlines the basic characteristics of DS. It is ‘capitalistic’, abiding by the fundamental values of capitalism such as its market mechanisms and stance on property rights. It is ‘developmental’ because the state is committed to lead industrialisation.

Embedded autonomy posits that DS could avoid government failures such as rent-seeking and corruption via policy instruments to reward or punish key industrial sectors. Therefore, DS require a meritocratic type of bureaucracy that operates independently from external pressure while maintaining strong links with society. For instance, in Korea and Japan, nationalism and social homogeneity allowed governments and businesses to introduce meritocratic measures.

Strong DS rely upon the formation of agreements with the private sector. Each DS is built within different political settlements, guided by their own developmental project. Doner (2005) points out that it is necessary to maintain a broad coalition as such pressure fosters growth rates, while Wade (1990) and Vu (2007) argue in favour of narrow coalitions because they guarantee greater autonomy, i.e.: Korea’s narrow, oppressive coalition resulted in a more effective DS than Indonesia’s inclusive yet weak broad coalition.

State-business relations are vital in the DS narrative. Therefore, bureaucratic autonomy, state efficiency and state-business alliances are paramount in enabling states to design and implement market appropriate industrial policies.

Historically, both Korea and Indonesia have been invaded by foreign powers. Japanese occupancy had a positive impact in Korea’s transition into a development process in two major ways: its bureaucratic structures and its institutional strength. These legacies can be devised in the emergence of a coherent bureaucracy and strong businesses-government alliances which were brought about later at Korea’s state-formation stage. Prior to the colonial period, Korea was almost an entirely agrarian economy. Between 1910 and 1945, the country experienced rapid economic growth and structural transformation, largely due to Japanese scientific approach to agriculture and infrastructure. Japan perceived its colonies as supporting elements of its development, thus the progress of its colonies was an obvious collateral effect.

With Dutch Occupancy, Indonesia took on the role of a supplier; industrialisation per se was not promoted but rather continuous trade activities which failed to generate entrepreneurial human capital. Also, Indonesia inherited the ‘ethnic division of labour’, a measure to categorise society, which resulted in higher inequality.

The impact of the Japanese legacy in Korea’s development outcomes remains contested as elite-mass relations during the post-decolonisation period had a highly significant impact in building Korea’s institutional strength. As for Indonesia, they inherited a much less institutional legacy from the Dutch colonial period, social and economic disparities and a collective tendency towards rent-seeking activities. Therefore, it can be argued that Indonesia’s industrialisation process was delayed.

The geo-political circumstances in which Korea emerged as a DS favoured its economic project by determining its industrial and export opportunities. First, Japanese regional domination promoted Korea’s economic integration into regional markets. Second, Korea benefitted from its good relations with the United States given their interest in preventing communist expansion. The US provided strong economic aid, political and military support and opened American markets to Korea, furthering its export-oriented growth. Indonesia was surrounded by almost all non-communist countries and therefore, it was not a political priority in US foreign policy.

The timely implementation of land reforms in the early stages of development is crucial in agrarian economies and Korea’s developmental journey illustrates this claim. The land reform encouraged production by providing training, access to credit and even granting parcels. By 1960, Korea’s economy was based on agriculture and infrastructure work was mainly focused on irrigation facilities. The land reform in this case helped to equalise income across society.

Meanwhile Indonesia’s agricultural industry performed poorly due to its low productivity. The land reform implemented by President Sukarmo in 1960 faced various challenges including the inability of institutions to reconcile high population density with land redistribution and its inability to deliver the programme fairly. Although the country achieved moderate success in the production of rice, land ownership remained problematic and Korea’s production was still higher.

As evidenced in both cases, agricultural and rural policies are key determinants of development outcomes.  First, the efficient land distribution strategy implemented in Korea improved rural income. This translated directly into mass poverty alleviation, and indirectly created the conditions for industrial development. Second, in expanding land ownership, Korea changed the elite-based agricultural ownership structure to one that benefits smallholder farmers. Conversely, the outcomes of land reform in Indonesia were less transformative.

Korea’s strategy to drive industrialisation was based on the idea of ‘export discipline’; state-driven policies to reward domestic manufacturers via subsidies based on their performance. Additionally, the government made it compulsory for foreign companies to bring knowledge and technology resources into the country which in turn made domestic companies more competitive. Korea’s path towards development started in 1961 with the Park government focusing on promoting entrepreneurship by providing credit and opportunities for direct involvement in infrastructure projects. In 1973, the Park regime introduced the Heavy and Chemical Industrialisation programme guiding Korean industrial power. Park’s strategy was indeed successful at increasing exports, rising from 35 to 75 percent between 1973 and 1984. In Indonesia, Industrial policy had not been a priority prior to the Suharto Regime. His approach to economic development, heavily informed by World Bank and IMF policies, proposed a free market approach to industrialisation. These initiatives were, nonetheless, hindered by the country’s technological deficiencies. The experience of both countries demonstrates that despite having attained some success in agriculture (although in different proportions), the development of their manufacturing industries was key to consolidate the basis for development, alongside an adequate policy framework.

State intervention was repeatedly displayed in Korea’s financial policy record and the Park regime concentrated on the promotion of emerging exporters. In 1992, the Korean Bank became a subsidiary of the Ministry of Finance, which created a financial environment more conducive for exports. The World Bank and IMF continued to encourage a more orthodox approach to financial management than Korea had chosen to take and even though the Asian Financial Crisis had affected the Korean economy between 1997 and 1999, the country was able to recover quickly, with prior financial policy supporting industrialisation and promoting export-oriented growth.

Financial policy in Indonesia was not as successful. President Sukarmo introduced a lending system for commercial purposes and created two additional development-oriented financial agencies. Major challenges, nonetheless, limited the effectiveness of these initiatives: the lack of an industrial policy framework to support exports and the new lending system promoting imports rather than exports. Additionally, the ‘affirmative action’ programme through which indigenous entrepreneurs were given access to land in order to encourage trade only favoured a small elite. In 1980, Suharto deregulated the financial sector, so as to capitalise on the market dynamics. This measure encouraged banks and entrepreneurs to take on short-term loans which affected severely the national currency. Export-oriented entrepreneurs relocated in more technologically advanced environments like China and Taiwan. As a result, the Indonesian economy was severely affected by the financial policy implemented during this period, being only able to recover in 2009.

It is evident that timely and efficient regulations are essential conditions for states to reach the developmental status. Korea and Indonesia emerged as DS due to their independence. Breaking away from the colonial legacy left behind by Japan and the Netherlands outlined the following scenarios: Korea certainly succeeded in equalising income. It did so thanks to its successful land reform, which subsequently created a social structure that favoured the autonomy of the state as well as a professional bureaucratic system that in turn fostered other key areas of development such as education. In contrast, Indonesia inherited the characteristics of the colonial rule, including income inequality deeply rooted in the ‘ethnic division of labour’. Indonesia’s journey towards economic development was delayed by the dictatorship of president Sukarno, whose financial intervention deepened the country’s economic problems and failed to bridge agricultural success and industrialisation.

Bibliography:

Doner, R. F., Ritchie, B. K. & Slater, D. (2005). Systematic Vulnerability and the Origins of Developmental States: Northeast and Southeast Asia in Comparative Perspective. International Organisation, 59, 327-361.

Studwell, J. (2013). How Asia Works: Success And Failure In The World’s Most Dynamic Region. London, Profile Books.

Vu, T. (2007). State Formation and the Origins of Developmental States in South Korea and Indonesia. Studies in Comparative International Development, 41(4), 27-56.

Wade, R. (1990). Governing the Market: Economic Theory and the Role of Government in East Asian Industrialisation. Princeton, NJ Princeton University Press.