5.

ECONOMIC CRISIS OF 1997 IN SOUTH KOREA

At the end off 1997, South Korea companies were unable to pay off their loans, the stock market
crashed and the Korean currency lost half of its value. The South Korean government had go begging to
the International Monetary Fund for a $58 billion loan---the biggest IMF rescue package ever---but even
that wasn't enough. Japan, the United States and other countries coughed up more money to prevent
the South Korean economy from totally collapsing.

Unemployment rose from 2 or 3 percent to 8.7 percent. At end of December 1997, the stock market had
declined by 49 percent and the currency had depreciated by 65.9 percent. A black market for dollars
opened in Myongdong in Seoul. Growth in 1998 was -7.8 percent.

The 1997-1998 Asian financial crisis was a blow to South Korea's pride. The crisis took hold just months
the country reached the $10,000 per capita income level for the first. The collapse of the won (the South
Korean currency) quickly reduced it to $6,600 and the world's 11th largest economy was suddenly the
17th largest economy behind Russia, Mexico, India and the Netherlands.

Problems began in July, 1997 when Thailand devalued its currency and markets fell all over Asia.
Investors began taking a hard look at South Korea and they were not happy with what they saw: namely
inefficient companies with massive debt burdens. They began taking their money out of South Korea
and tightening credit. By October, foreign reserve were dwindling dangerously low. Without a supply of
credit, Korean companies found themselves unable to pay back their loans and faced defaulting. The
entire South Korean economy came close to collapsing.

The crisis in South Korea was rooted in its chaebols (large industrial conglomerates) which had their
fingers in many pies, often spent money wastefully and had accrued massive debts. South Korea's
financial problems began in earnest with the collapse of Hanbo Steel, an arm of Hanbo, the country's
14th largest chaebol. The company had borrowed $6 billion to build a huge modern steel plant on a
capital base of $343 million. By 1997, Hanbo's debt was 22 times more than its net worth. The Hanbo
Group had 23 subsidiaries, 22,000 employees and annual sales of $8 billion. In early December 1997, the
Halla Group, South Korea's 12th largest chaebol, went bankrupt, with debts that were 30 times its
equity.

Also in early December 1997, the Korean government revealed it was $160 billion in debt (the figure
would expanded to $450 billion, 1.5 times South Korea's GNP, a month later). In a meeting in mid-
December, the Clinton administration decided that if South Korea wasn't saved the collapse of its
economy could set off a dangerous chain reaction that might have repercussions all around the globe, so
it put in motion a rescue plan.

Causes of Economic Crisis of 1997 in South Korea

The immediate main cause of the crisis was a shortage of foreign reserves, which had been sucked up by
government-backed low interest-loans given to risky investments and expansion programs by the
chaebols. Knowing that the government would bail them out, the chaebols seemed more intent on
taking over the world than making profits. They produced millions of products with establishing market
share as their primary objective.

Chaebol waste was closely tied to corruption and cronyism between the chaebols and the South Korean
government. In addition, concessions to labor created higher wages and made it more difficult to lay off
workers. Companies were vastly overstaffed.

The chaebols invested heavily in wasteful projects. They sunk billions into semiconductors and auto
manufacturing and even things like aircraft making and movies. Samsung and Ssangyong started mult-
billion auto industries in a market that was already flooded. Samsung invested $6 billion in a plant
capable of producing 60,000 luxury cars a year "because the chairman likes fast cars." The chairman of
Ssnagyang was a "car maniac" who once owned 20 cars including a Jaguar, Lotus, Lamborghini, BMW
and Mercedes.

Much of South Korea's debt was owed by the chaebols. The chaebols maintained debt burdens three
times that of businesses in the West. Their debt to equity ratio was an astonishing 400 to 1,000 percent.
They started costly businesses at the drop of a hat and were so heavily in debt they tied down much of
the country's money.

In 1997, seven chaebols announced they were insolvent. Among the other major chaebols that went
bankrupt in 1997, in addition to the Hano and Hall Groups, were Sammi Steel ($2 billion in debt) and Kia
Motors. Jinro Distillery, the nations 19th largest company nearly went bankrupt. Even though Kia was
bankrupt it still produced 40,000 cars a month and talked about becoming a "top-10 global automaker in
the 21st century." Its plant was capable of producing 650,000 cars a year, with 90 percent of the work
done by robots. Daewoo acquired Ssangyong's car plant without paying a penny. It simply assumed 60
percent of Ssnagyang's debt.

The bankruptcies also hurt thousands of subcontractors that did businesses with the bankrupt
companies. Unable to get credit and payment they too had to declare bankruptcy. In 1998, 1,000
companies went bankrupt a month.

Impacts of the Economic Crisis of 1997 in South Korea

During the Asian financial crisis in South Korea, shoppers stormed supermarkets and hoarded foreign
products; workers shaved their heads to protests lay-offs. Newspapers had few pages. Television
stations broadcast at shorter hours. Stores replaced imported products with domestic ones. In an efforts
to raise foreign currency, companies encouraged workers to turn in loose dollars or yen they might have
lying around the house. Executives accepted 20 percent pay cuts. a clothing manufacturer forced to lay
off a third of its work force told Newsweek, "Before, companies that had done business with us for a
decade would help us out in times of trouble. But no more."

Security guards were brought in to restore order outside banks that we in danger of collapsing. Analysts
said the country was "just 10 days away" from "a major financial catastrophe." One economist told
Newsweek, "A year ago foreign banks were so eager to lend us money. Now some of them don't even
answer our phone calls...Asking the IMF for help is like filing for national receivership."
Restaurants offered IMF menus; citizens stocked up on bulk supplies of milk and flour; expense accounts
were curbed; street lamps were turned off; commuters stopped driving; and teachers encouraged
student to use their pencils until they were stubs. Public holidays were canceled. Weddings and trips
were postponed. Elevators were programmed to stop at every other floor to save energy. Hospitals---
which imported 90 percent of their supplies---delayed nonemergency surgeries.

Koreans complained that there was too much foreign meddling in Korean affairs. Problems were blamed
on the IMF and foreign investors. As part of the xenophobia backlash, foreign shows were canceled;
protesters at the airport harassed Koreans leaving for foreign vacations, schoolgirls burned foreign
products; and smokers refused to buy foreign cigarettes, Financial analysts said some of these moves
were self destructive because no one would want to lend them money.

Ordinary South Korean were encouraged to turn in their wedding rings and jewelry so they so be
melting down to boost gold reserves. One bank manager said, "there's a Korean saying that by gathering
dust you can create a mountain." The gold drive collected 15 tons of gold and raised $2 billion. Korean-
Americans sent hundreds of millions of dollars to South Korea. Even so it barely made a dent in the
money that South Korea owed. There were rumors that Japan would extend $10 billion in emergency
funds in return for disputed Tokdo islands.

Korea and the International Monetary Fund

The IMF exists as a security blanket for countries that experience major economic dilemmas. Yet, the
need for an institution such as the IMF is often debated. The strongest argument in favor is that,
without access to conditional financing, troubled countries are likely to respond to negative economic
shocks with unsound macroeconomic policies (i.e. currency devaluations and trade controls such as
tariffs and quotas). There would essentially be no other choice. However, the main argument against
the IMF centers around the moral hazard problem it creates. Knowing that they will be bailed out of any
major economic trouble, financially unstable countries, as well as developing countries, have incentive
to undertake excessively risky behavior (predominantly in the banking sector) in an attempt to right
their economic ship or develop at a faster rate. A close look at how the IMF dealt with Korea during its
economic difficulties will reveal some of the costs and benefits of having this kind of protective
institution. Whether the net effect of IMF policy on the Korean economy is good or bad, it is likely that
the mere presence of the IMF helped induce the type of morally hazardous investment behavior that led
up to the Asian financial crisis.
In late November 1997, following the dramatic plunge of the Korean won on the foreign exchange
market, a team of IMF economists was rushed to Seoul to negotiate the terms of a massive bail-out
package with the design of restoring health and stability to the Korean economy. In close consultation
with IMF negotiators, the World Bank and the Asian Development Bank also sent their own teams of
economists. A World Bank package with stringent conditionalities on financial governance was
announced on December 18th. During the process, an important precedent was set. The IMF's
standard measures of economic reform had been launched for the first time in an advanced
industrialized economy. (External Relations Department, 1998)
The IMF put together a $60 billion bail-out package for Korea, but it is the structural provisions of
the bail-out that are more interesting and important:
--increased flexibility of exchange rates
--a temporary tightening of monetary policy to stem balance of payment pressures
--structural reforms to remove features of the economy that had become
impediments to growth (such as monopolies, trade barriers, and nontransparent
corporate practices)
--opening and maintaining lines of external financing
--the closure of unviable financial institutions (and close supervision of weak ones)
--the recapitalization of undercapitalized institutions
--increased foreign participation in domestic financial markets
Korea’s regulatory reform
Regulatory reform programs have been core part of the Korean public sector reform since the financial
crisis in 1997. The economic crisis, in the short term, was triggered by the onset of foreign exchange
crisis in Southeast Asia in 1997. However, in the long term, it resulted from structural weaknesses
accumulated in a state-led development of last three decades. The guiding principle of reform policy
was to achieve the parallel development of democracy and a market economy. Pursuing the balanced
development of democracy and a market economy requires a full-scale change in the policy paradigm. It
means a paradigm shift from a state-led development strategy to a market driven development. The
Korean government initiated drastic regulatory reform programs in parallel with structural reforms in
several sectors such as finance, corporate and public. They were all aimed to promote the efficiency and
discipline using market principle and market force. These reform measures in a broad sense included
changes in regulatory systems and methods, and policy tools. Farreaching efforts at reform of regulation
were conducted. A strong political leadership combined with a sound institutional framework for
regulatory reform made it possible to carry out drastic and comprehensive reform of regulation.