Date: Wed, 31 Dec 1997 12:35:24 -0800
Sender: Forum on Labor in the Global Economy <LABOR-L@YORKU.CA>
From: Sid Shniad <shniad@SFU.CA>
Subject: Korea -- crisis of underregulation
Perspective on Korea: A crisis from underregulation; The deflationary bias of the International Monetary
Fund made the credit crunch worse, leading to bankruptcies
By Ha-Joon Chang, Los Angeles Times,
31 December 1997
[W]hen the Korean crisis first broke out, many commentators
argued that it was the result of an intrusive state
forcing banks to lend to unprofitable firms. The medicine to
cure the country's economic ills, it was argued, was to ditch
the defunct state directed economic system, which some people
likened to those of the Soviet Union or East Germany, and to
create in its place a "genuine" market economy through an
extensive liberalization of finance, international trade and
the labor market. But is this a valid approach?
The current Korean crisis is essentially a financial
problem rather than a crisis of the "real economy." Most of
the country's manufacturing firms make products that sell
even in the most demanding markets--if the exchange rate is
right. During the last couple of years, the won clearly was
overvalued by 10% to 20%; but even then, on the eve of the
crisis, the current account deficit was just over 3% of gross
domestic product and is now falling after the recent
devaluation. Yet we saw current account deficits of 8% to 10%
in Thailand and Mexico before their recent crises, and in
previous downturns Korea had current account deficits
approaching 9% of GDP. Furthermore, most foreign loans
financed investments in export sectors rather than real
estate development or imports of consumer goods, as was the
case in Mexico and Southeast Asia. The Korean budget is
largely in balance and gross public debt amounts to only 3%
of GDP. There has been little significant inflationary
pressure in the economy. Then why did Korea crash?
The current crisis is largely the result of a policy
failure by the outgoing government of Kim Young Sam. It is
failure of underregulation rather than of overregulation as
the popular view holds. Deregulation had been the proclaimed
policy objective of Kim's government, and although no radical
deregulation occurred, state control relaxed enough to make
important differences. The government abandoned its
traditional role of coordinating investments in large-scale
industries, thus allowing excess capacities to emerge in
industries like automobiles, shipbuilding, steel,
petrochemicals and semiconductors, which eventually led to
the fall in export prices and the accumulation of
nonperforming loans.
In the name of financial liberalization, the government
also failed to monitor properly foreign borrowing activities,
especially by inexperienced merchant banks. This resulted in
a rapid buildup of debts totaling $100 billion with a very
poor maturity structure; 70% of these debts carry less than a
year's maturity. Finally, Kim's advisors were sold on the
monetarist idea that inflation control is the most important
objective of government policy and that the exchange rate
should be an "anchor" in inflation control. This caused a
significant overvaluation of the currency, hurting export
performance.
The Kim government was confused and incompetent as the
economic troubles began. It dithered over the fate of the
third largest car manufacturer, Kia, unnecessarily
undermining confidence in the economy. As the currency crisis
grew, it wasted $10 billion (more than one-third of its
dwindling foreign exchange reserve) trying to defend an
indefensible exchange rate, thus exacerbating the foreign
exchange shortage. External causes also came into play.
Southeast Asia's doldrums reduced demand for Korean exports
and dealt a blow to some Korean financial companies that had
been speculating in Southeast Asian financial markets. The
entrance of new Taiwanese semiconductor manufacturers drove
down the prices of memory chips, which accounted for nearly
20% of Korean exports when their prices were high. Chip
prices fell from nearly $50 to $4. But the main problem was a
failure of oversight by a government priding itself on
deregulation.
Having met the crisis, is the International Monetary
Fund program the best medicine for Korea? The second bailout
at the end of December underlines a number of important
problems with the basic IMF package. First, its strong
deflationary bias made the credit crunch that firms are
facing even worse, leading to a chain of bankruptcies and
possibly driving the economy toward depression. The IMF's 5%
inflation target was already too deflationary, given that the
economy has to deal with a big rise in import prices due to
devaluation; with the excess liquidity released by financial
sector bailouts and the further fall of the currency since
the signing of the agreement, this target now seems
indefensible.
More worrying than the deflationary bias of the IMF is
its insistence on financial liberalization of the economy.
Korea needs better, not less, financial regulation. Bad debts
need to be cleaned up before the banks can be granted more
freedom. Moreover, more time is needed to determine which are
the really viable financial institutions and which need to be
closed down. All of this requires time, which the IMF program
does not allow. Worse, the IMF wants a quick opening up of
financial markets to foreign participation, which exposes the
economy to high volatility. What such volatility can do to an
economy is clearly shown by Chile in the late 1970s and
recent experiences in Mexico and Southeast Asia.
Finally, the IMF acted without consulting the Korean
people, leading to widespread talk of national humiliation
and foreign trusteeship. The likely result is that the IMF
program, with its heavy deflationary bias, will result in a
sharp rise in unemployment and will be met by massive
political resistance. The IMF's way of meeting these dangers
was to say that the country needs to strengthen its
unemployment insurance system, as if this can be achieved at
a time of fiscal retrenchment. If the political backlash
materializes, the entire IMF program will be jeopardized.
The new government of Kim Dae Jung, with its more
consensual approach to politics and stronger ties to the
small firms and trade unions that are going to be hurt most
in the process, may be in a better position to pull the
country through a period of deflation and job losses and
toward robust growth. But it must also find new ways to
reinvigorate the coordinating and regulatory mechanisms of
previous governments without the negative features of the old
system, such as corruption, nepotism and excessive
bureaucratic rigidity.
Ha-joon Chang Is a Member of the Faculty of Economics and
Politics at the University of Cambridge, England. His Latest
Book Is "The Political Economy of Industrial Policy" (St.
Martin's Press, 1994)
Copyright Los Angeles Times
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