Trade Policy and South Korea's Growth Miracle

What effects do more open trade policies have on transitional and long run growth rates? This is the central question in trade and growth. Yet, despite numerous empirical studies over the past twenty-five years there are almost no enduring, robust results on the importance of (openness to) trade in causing growth and on the mechanisms through which trade influences growth. Our approach is to engage in a quantitative exercise focused on a single country, South Korea (hereafter, Korea). We build a model of trade and growth; we calibrate and parameterize the model; and then we simulate the model’s response to Korea’s trade policy reforms to assess whether they can explain Korea’s sustained surge in growth that began in the early 1960s. A case study of Korea is interesting for three reasons. First, it is one of just a handful of countries that is considered to be a growth “miracle†country. Second, there is broad agreement that new and different policies and institutions played a crucial role in Korea’s growth surge. Third, data are relatively accessible. We have collected data on four of the most important trade-oriented policy changes for exporters in Korea during the 1960s: Tariff reductions for imports of intermediate and capital goods, introduction of export subsidies, direct and indirect tax reductions, and introduction of low interest rate loans. Beyond the well known surge in exports (and in investment and GDP per capita), Korea’s trade experience after these policy changes included a strong expansion of the range and quality of its export goods, a heavy reliance on imported inputs and imported capital in producing its exports, and possible learning-by-doing or learning-by-exporting effects. The policy changes and these three key features of Korea’s trade experience guide our model. It is a dynamic two-country model (the second country is the rest-of-the-world) with a continuum of goods. Each good is produced in two sequential stages: comparative advantage will determine which stages of which goods Korea specializes in (vertical specialization). Additionally, there are fixed costs of exporting, which decline with cumulated exporting experience. The key channel in our model is the one linking Korea’s trade policy reforms to increased imported inputs and capital, thereby leading Korea to produce an increased range of export goods. Our model allows for Korea to both specialize, consistent with standard trade theory, and expand the range of goods it produces, consistent with a growing economy. The availability of imported capital and inputs improves growth for Korea. Learning-by-exporting further increases transitional growth rates, thereby enabling Korea’s per capita income to at least partially catch up to the rest of the world in steady-state.