Structural Causes of South Korea’s Economic Crisis.

Structural Causes of South Korea’s Economic Crisis

Japan and South Korea

• Japan’s colonial rule (1910 - 1945)– 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 (1917 - 1979)

• 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 (1998 - 2003)

• 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?