23 Things They Don't Tell You About Capitalism

Governments can pick winners, sometimes spectacularly well. When we look around with an open mind, there are many examples of successful winner-picking by governments from all over the world. The argument that government decisions affecting business firms are bound to be inferior to the decisions made by the firms themselves is unwarranted. Having more detailed information does not guarantee better decisions – it may actually be more difficult to make the right decision, if one is ‘in the thick of it’. Also, there are ways for the government to acquire better information and improve the quality of its decisions. Moreover, decisions that are good for individual firms may not be good for the national economy as a whole. Therefore, the government picking winners against market signals can improve national economic performance, especially if it is done in close (but not too close) collaboration with the private sector.

The worst business proposition in human history

Eugene Black, the longest-serving president in the history of the World Bank (1949–63), is reported to have criticized developing countries for being fixated on three totems – the highway, the integrated steel mill and the monument to the head of the state.

Mr Black’s remark on the monument may have been unfair (many political leaders in developing countries at the time were not self-aggrandizing), but he was right to be worried about the then widespread tendency to go for prestige projects, such as highways and steel mills, regardless of their economic viability. At the time, too many developing countries built highways that remained empty and steel mills that survived only because of massive government subsidies and tariff protection. Expressions like ‘white elephant’ or ‘castle in the desert’ were invented during this period to describe such projects.

But of all the then potential castles in the desert, South Korea’s plan to build an integrated steel mill, hatched in 1965, was one of the most outlandish.

At the time, Korea was one of the poorest countries in the world, relying on natural resource-based exports (e.g., fish, tungsten ore) or labour-intensive manufactured exports (e.g., wigs made with human hair, cheap garments). According to the received theory of international trade, known as the ‘theory of comparative advantage’, a country like Korea, with a lot of labour and very little capital, should notbe making capital-intensive products, like steel.[1]

Worse, Korea did not even produce the necessary raw materials. Sweden developed an iron and steel industry quite naturally because it has a lot of iron ore deposits. Korea produced virtually no iron ore or coking coal, the two key ingredients of modern steel-making. Today, these could have been imported from China, but this was the time of the Cold War when there was no trade between China and South Korea. So the raw materials had to be imported from countries such as Australia, Canada and the US – all of them five or six thousand miles away – thereby significantly adding to the cost of production.

No wonder the Korean government was finding it difficult to convince potential foreign donors and lenders of its plan, even though it proposed to subsidize the steel mill left, right and centre – free infrastructure (ports, roads, railroads), tax breaks, accelerated depreciation of its capital equipment (so that tax liabilities would be minimized in the early years), reduced utility rates, and what not.

While the negotiations with potential donors – such as the World Bank and the governments of the US, UK, West Germany, France and Italy – were going on, the Korean government did things to make the project look even less appealing. When the company to run the steel mill – the Pohang Iron and Steel Company (POSCO) – was set up in 1968, it was as a state-owned enterprise (SOE), despite widespread concerns about the inefficiencies of SOEs in developing countries. And to cap it all, the company was to be led by Mr Park Tae-Joon, a former army general with minimal business experience as the head of a state-owned tungsten-mining company for a few years. Even for a military dictatorship, this was going too far. The country was about to start the biggest business venture in its history, and the man put in charge was not even a professional businessman!

Thus, the potential donors faced arguably the worst business proposal in human history – a state-owned company, run by a politically appointed soldier, making a product that all received economic theories said was not suitable to the country. Naturally, the World Bank advised the other potential donors not to support the project, and every one of them officially pulled out of the negotiations in April 1969.