Structural Causes of South Korea’s Economic Crisis

Japan and South Korea Japan’s colonial rule ( ) –bitter memories –normalization in relationships (1965) Japan’s economic model –import substitution –large interlocked corporations –protection of domestic market

South Korea’s political legacy Strong presidency, center of state –legacy of Park Chung Hee –control over policy process Bureaucracy and business interests other political institutions underdeveloped –legislature –political parties –interest groups

Park Chung Hee ( ) Served in Japanese air force in WWII became a general in South Korean army led a bloodless military coup in 1961 became president after 1963 election imposed martial law in 1972 –presidential decree assassinated in 1979 by the head of KCIA

Park’s strategies prosperity and independence by pursuit of a high-growth economic strategy Park took accepted economic theory Park’s observation of the wartime Japanese economic model Park’s fervent nationalistic exhortations Korean people’s willingness to accept, obey authority, and to sacrifice

Chaebol Park nationalized all the Korean banks reinforced the system of chaebol –a few specially selected large companies –encouraged to tailor their growth and production targets to meet government objectives –dependent on those state-owned banks for the credit they needed to operate and grow

Chaebol A conglomerate of many companies companies hold shares in each other concentration of national economy does not have own financial institution spreads across industries has centralized structure and control tends to be family-based

A strong state state controlled virtually all economic activities in South Korea –government approved all bank loans –granted licenses for virtually all businesses –controlled many prices copied much of the Japanese model –with a heavier emphasis on political and military influence in running the economy

Economic Planning Board Park’s personal involvement Elaborate economic plans –five-year plan –annual economic management plan added more responsibilities –price policy –fair trade administration –reviews of projects

Hands of the new economy Ministry of Commerce and Industry –later known as the Ministry of Trade and Industry, or MTI Ministry of Finance –nationalization of the banks –centralization of the financial system day-to-day contact with businessmen who wanted approval for projects

Nationalism versus pragmatism International export market to make sure that companies were competitive industrial expansion needed to be financed by foreign bankers foreign companies were the best source of competitive technology normalized diplomatic relations with Japan in 1965

Export promotion The administration made exporting into a national campaign, almost a patriotic duty. export producers were given priority in investment decisions, credit allocations, and other benefits strategy of forcing domestic consumers to subsidize exports Korea Traders Association

Crisis in South Korea 1997 chaebol crisis (bankruptcies) financial crisis –credit rating downgraded –exchange rate of won –stock market economic crisis –economic growth rate and GNP per capita –unemployment rate

Chaebol’s advantages Governance structures of chaebol –centralized control and management –lack of monitor or sanction by shareholders Organizational advantages –mobilization of resources for new businesses –economy of scale through sharing resources –safety-net for member companies in crisis

Chaebol’s advantages Park’s economic policy –promotion of export-oriented industries –promotion of heavy industry –suppression of labor movements –protection of domestic market –allocation of resources to chaebol heyday of chaebol growth –mid-1960s to mid-1980s

“Octopus companies” Chaebol’s diversification –unrelated new industries strategic consideration –reduction of financial risk environmental incentive –“industrial vacuum”

Environmental changes Challenges since 1980s political regime shifts foreign pressure to open domestic market rise in labor cost competition from other Asian countries chaebol became multinationals industrial shift and competition

Democratization in ROK 1987 election, former general Roh Tae Woo defeated opposition leaders Kim Dae Jung and Kim Young Sam 1987, Declaration of Political Reforms 1988 election, opposition parties won majority in National Assembly Kim Young Sam won presidential election in 1992 (1st elected civilian president)

Regime shift Democratization deregulation –land use (1990) –import liberalization (1992) –open stock market to foreigners (1992) –open domestic capital market (1994) –deregulate loan financing in foreign market (1994)

Labor cost

Chaebol responses Unrelated diversification in new industries –diversion of resources from technological innovation –demand for domestic financial resources accumulated bank loans –demand for foreign financial resources opening of the domestic financial market centralized control and management

Negative consequences Chaebol’s expansion –lack of transparency and accountability domestic loans –government pressure on banks foreign loans –government opened capital market yet controlled exchange rate

Regime shift continued President Kim Dae Jung ( ) free market –minimizing government intervention –deregulation

IMF conditionality borrower government makes commitments on economic and financial policies Most loans feature phased disbursements –prior actions before approval and initial disbursement –performance criteria quantitative and structural condition for agreed credit to be disbursed –program review

Restructure the financial sector Troubled banks –bankrupt –sold to foreign banks –merged Financial Supervisory Board –power to replace top managers of banks –resurrection of Park’s policies?

Improve chaebol finance reduce debt-capital ratio –sale of assets –foreign investors prohibit cross-investment prohibit internal trading consolidated financial statements

Chaebol reforms Transform governance structure weaken the centralized control and management in chaebol –owner became formal CEO full legal responsibilities –outside board members –legal right for minority shareholders restrict unrelated diversification

Dilemmas for government Government intervention to establish free market economy?