Foreign capital inflows, growth, and debt servicing capacity: The case of South Korea (1957-1984)

The present study deals with the analysis of the investment and debt roles of capital inflows in the growth process of the Korean economy for the period 1957-1984. The growth effect of the investment role of capital inflows is analyzed within the framework of a two-gap model oriented toward South Korea. In order to establish the reliability of the growth effect the structure of the model was extended to incorporate CES production functions in terms of which the plausibility of the no substitution assumptions between factors underlying them are verified empirically. An interesting side light to these analyses is the investigation of the issue of whether or not Korea experienced changes in the structure of its economy within the framework of an output exports function. From this we tried to show if it is possible to draw the inference that capital inflows contributed to bringing changes in the structure of the economy. Capital inflows have debt effect. This effect has adverse consequences on growth. Hence only if a foreign capital dependent economy succeeds in maintaining continued high growth by sustaining a satisfactory debt service capacity can one argue that the economy benefited by the capital inflows. For this reason we examined its debt role in the context of Korea's experience within the framework of a multidimensional indicator-based model which involves three interrelated analytic schemes: the individual ratio analysis, the paired ratio analysis and the decomposition analysis. The growth effect of capital inflows was quantitatively determined by estimating the structural equations of the Korean dual gap model. Our results seem to suggest that it played a positive role. The low measures of elasticity of substitution between factors we obtained seem to support the reliability of this finding. Also the plausibility of the fact that Korea experienced structural change is confirmed by our finding. And our analysis of the debt role of capital inflows in Korea suggests that its debt service capacity had been satisfactory. From all this we concluded that Korea made a productive use of capital inflows by increasing aggregate output levels and by changing its structure. The present study suggests that this was made possible by a shift in economic policies the most notable of which were in fiscal policy, exchange rate and trade policy and in interest rate policy. Nevertheless, this was counterbalanced by the conclusion that in the future policy changes will have to be made to correct the growth imbalances created between sectors and regions over the last three decades.