South Korea’s remarkable revival from the financial crisis of five years ago is just the latest example of the country’s spirit of collective survival at work. As Yoon Tae-Hee describes, South Korea’s reform and renaissance provides a role model for other nations and is testimony to an extraordinary, perhaps unique, sense of national determination –
Few nations have gone through the political, social and economic transformations that Korea has experienced in the past 50 years. At the close of World War II, on being finally liberated from 36 long and brutal years of Japanese colonial rule, the Korean peninsula was divided in two.
Within two years of its birth, the Republic of Korea, or South Korea as this new nation state is commonly known, was subjected to a devastating three-year conflict. This destroyed what little productive infrastructure it had, with the notable exception of its land and its people.
Those who lived through the Korean War and its aftermath still vividly remember the overwhelming poverty of those bitterly cold winters. Within a few decades, however, South Korea took its place among the leading nations of the world, emerging as a major industrial power and creating the “Korean Miracle” as development economics jargon has dubbed it.
A per capita annual income of $10,000 underpinned its position as one of the world’s dozen largest economies. Ultimately, its burgeoning economy led to its admission into the OECD. Korea had transformed itself from a subsistence agrarian economy to an industrial nation, boasting some of the world’s largest production capacities in steel, automobile manufacturing, shipbuilding, electronics and IT-related technologies. There were also outstanding achievements in social policy, with illiteracy and absolute poverty successfully tackled.
In political terms, the Korean people finally won their long fought after freedom from military dictatorship, as well as the right to elect their own leaders in free elections.
These achievements were first perceived as somehow flawed during the 1997-98 financial crisis that ultimately led the government to resort to a massive IMF bailout package that imposed stringent policy reforms.
Korea was subjected to the unusual political humiliation of each presidential candidate being compelled to make public promises to the IMF, to the effect that they would accept the IMF reform programme should they be elected.
Five years later, Korea successfully elected another new government on December 19 2002, the electorate having been promised “ a new democracy and further prosperity”.
Although Korea may share traits with other economies that have ended up in dire straits, there were unique factors leading up to its 1997-1998 financial crisis. Up to that point, economic growth had been based on state-induced export promotion, which favoured selected sectors and beneficiaries when it came to resource allocation and business opportunities.
The system exemplified the insufficient sensitivity to profitability as a guiding criterion for investment by the chaebols (conglomerates), in their ever-expanding domestic and overseas investments. This manifested itself in the high leverage and over-capitalization of Korean companies, based on borrowed money and unfounded confidence in their competitiveness.
Although such a funding structure forced growth and served its purpose initially, the cumulative effects of unconstrained investment led to a major crisis of foreign exchange liquidity. Once the financial pinch was felt, corporate bankruptcies multiplied, weakening the already overburdened financial sector with non-performing loans and bad credit risks.
Foreigners lost confidence in Korea as the current account deficit rocketed. Foreign funds then started leaking out of the country, leading to an increasing foreign liquidity risk. This situation was exacerbated by an unacceptably high short-term debt/external debt ratio.
A chain reaction of such intensity provoked a psychological panic in whose wake came a collapse of the real estate and securities market. A large number of bankruptcies ensued.
The cumulative effect was that a full-blown economic, political and social crisis erupted, unprecedented in recent memory. Koreans refer to it as the “IMF Crisis” since it symbolized Korea’s humiliation at having to submit to the IMF bail-out conditions in November 1997.
The lack of advance warning of this crisis can be attributed to inadequate banking surveillance. A startling example is the way the then common merchant banks mismanaged the extension to customers of long term-loans based on short-term overseas credit.
Another inherent by-product of the Korean growth model was the endemic moral hazard at governmental and corporate levels, where the myth of “too big to fail” was prevalent. Such unsustainable practices greatly contributed to the absence of transparency and corporate governance, and weak financial accountability.
Fortunately, once the full-blown crisis hit, it served to ignite one of Korea’s patriotic traits – spontaneous union in a common objective of collective survival – which has invariably occurred throughout Korea’s long history of struggle against foreign intrusions.
A national consensus quickly emerged that lent full support to the newly elected coalition government in its fight to overcome foreign exchange liquidity problems and in its efforts to implement the structural reforms deemed necessary for the removal of problematic elements in the economic system.
The people’s determination to overcome the crisis could be witnessed on TV screens worldwide: emotional scenes in which numerous Koreans donated their cherished jewellery, family heirlooms, wedding rings and household treasures as their personal contribution toward resolving the national foreign currency crisis.
The government swiftly moved to secure a $35 billion IMF loan and the $23 billion debt was rescheduled. In addition to the measures taken to bolster foreign exchange reserves, a drastic tightening of fiscal and monetary policies was initiated that ultimately led to the stabilization of prices and foreign exchange rates.
Foreign investment was thus encouraged to return. Some of these emergency measures were relaxed at a later stage. Moreover, the government embarked on comprehensive and sweeping structural reforms, with broad policy objectives for promoting the transformation of the state-run economic management into a market-determined economic system.
Though the merits and appropriateness of such monetary and fiscal policies was questionable at such an early stage, the measures taken by the government were not in any way undermined by the debate that ensued, or by the reservations voiced by some observers.
As a result, Korea was able to achieve a growth rate of 10.9% and 9.3% in 1999 and 2000, respectively. In 2001, it became the first IMF rescue package recipient in Asia to repay its loan in full, three years ahead of schedule.
In October 2002, foreign exchange reserves reached a record $117 billion, compared with $4 billion at the time of the crisis. Direct foreign investment in 2001 was $11.9 billion, compared with $0.7 billion in 1997. The current account surplus in 2002 is projected at between $4 billion and $5 billion, compared with a 1997 deficit of $8.2 billion. Major international credit agencies have now reinstated Korea’s sovereign credit rating to the pre-crisis level.
There will no doubt be endless debates on the Korean reform efforts, producing different score cards depending on the differing positions of critics and analysts. It should be borne in mind, however, that reforms of this nature and magnitude could never be completely satisfactory. Nor is it possible that such reforms could be implemented entirely successfully in such a short time. Assuring their success and sustainability demands continuous efforts.
Given the large number of reforms that remain incomplete, there is no room for complacency. The government has attempted to broaden fundamental reforms in different sectors of the economy – corporate, finance/ banking, public and labour – in addition to general administrative and political reform efforts.
The first two sectors witnessed the most dramatic and irrevocable progress – one that will have a lasting impact on the Korean economy. The remaining areas must be addressed by the newly elected administration.
In order to maintain the competitiveness of the Korean economy, the elimination of labour force rigidity and the ability to hire and fire according to corporate requirements are the most important conditions for achieving sustainable growth.
Some of the fundamental reforms that future governments need to introduce include:
- reprivatization of the state-dominated commercial banks, created by massive injection of public funds;
- privatization of the inefficient state owned enterprises (SOEs), which is progressing at an unacceptably slow pace;
- expansion of social infrastructures commensurate with projected economic activities;
- wide-ranging administrative and political reforms including the upgrading of public services, and the eradication of corruption;
- the improvement of the general social safety net;
- improvements to the educational system that would align it to the needs of the national economy.
Among the revolutionary reforms quietly achieved during the past five years was the improvement in corporate transparency and decision-making accountability. Sixteen of the 30 largest chaebols were either restructured, sold, merged or liquidated during that period.
The average debt/equity ratio has dramatically improved from about 400 in 1997 to 135 in mid-2002. Transparency and management accountability were introduced through the mandatory publication of combined financial statements and the adoption of a system of non-executive, outside directors – although its operation is not as yet fully satisfactory. For the first time in its history, Korea is witnessing the emergence of professional managers, while simultaneously seeing the overnight disappearance of top-down business decision-making practices.
A notable clean-up operation was achieved in the financial system through restructuring and the injection of $130 billion of public funds. This resulted in the reduction of non-performing loans from $51 billion at the end of 1999 to $12 billion in mid-2002 (2.4% of total lending).
The number of financial institutions in Korea was reduced by nearly 30%, from 2,101 in 1997 to 1,548 in 2001. The banking sector has been undergoing massive consolidation and mergers as well as increasing autonomy from government, thereby increasing profitability.
The consolidation of banking is continuing. Other market-driven systems and the risk concept were introduced through the application of such systems as the new Bank for International Settlements capital adequacy criteria.
The most visible indication of the improvements in the corporate and financial sectors is the dramatic increase in foreign ownership of traded Korean companies since 1997. This in itself is truly impressive, especially if compared with how other economies coped with the Asian financial crisis, not to mention Japan’s dismal record in financial reform.
This raises the question: was there anything special or unique about Korea’s reform process?
Given the nature of the coalition government elected during the financial crisis, and the notorious Korean political culture of infighting and backbiting, it was remarkable that a minority partner party in the coalition was entrusted with structural and policy reform at the outset.
This is largely a result of the political leadership of Kim Daejung, although he was undoubtedly helped in this task by his people’s determination to turn an adverse situation into an opportunity.
Despite minor dissent and chaebol efforts to roll back progress achieved in the corporate and financial sectors, no opposition to the proposed reforms was effective enough to hinder the administration’s efforts. If anything, the fact that those reforms have not yet been completely carried out can be attributed to the subsequent deterioration in the leadership.
In any event, the Korean experience illustrates the need for determined political leadership in reform and crisis management.
One exogenous and thoroughly unique variable to South Korea’s economic future is the North Korea factor. Some 50 million “work hard, play hard” citizens of South Korea are prepared to confront this very likely challenge in order to survive in the unfolding Asian economic stage and ever changing world economy.
Korea has created a new comparative advantage, based on its expertise in high-tech industries and a knowledge-friendly workforce. As the most educated labour force in the world, the Koreans are quietly working on the cutting-edge of new technologies, such as information processing and communication technology.
One of the benefits of these efforts is reflected in recent statistics: some 51% of Koreans use the internet, and practically every school child in Seoul carries a cellular phone. Some forecasters expect Korea to lead the forthcoming “north-east Asian business and financial hub”.
But every important individual and national decision taken in South Korea is contingent on one assumption: that nothing goes wrong to the north. This has always been uniquely ironic: South Koreans are among the most promising but also the most vulnerable people on earth – without the practical means to determine their own future in an international context.
The South Korean government’s recent “sunshine policy” towards North Korea should not only be seen as a humanitarian gesture but also as a desperate effort to pursue survival and peace so that its citizens can enjoy the fruits of the economic prosperity for which they have fought so hard.
Dr Yoon Tae-Hee is president of Seoul University of Foreign Studies and senior adviser on Korea to the International Finance Corporation. He is also chairman of Korea Economic Intelligence in New York and adjunct professor of agricultural and applied economics at Clemson University, South Carolina. He was a senior staff member of the World Bank for 25 years and then vice-chairman of the financial advisory services practice at PricewaterhouseCoopers.