Financial Crisis in South Korea - Essay Example

Financial crisis in South Korea Prior to the Asian financial crisis in 1997, there were "tiger economies". The term was used to refer to those countries - Hongkong, Singapore, Korea and Taiwan - that had reached impressive and robust economic growth over the 90s resulting from export-oriented businesses attracting foreign investment. Asian entrepreneurs and political leaders received lauding for their economic decision to cooperate with the European and American financial institutions in order to restructure their economies in the worldwide market. The growth of the emerging market economies was so rapid that they were seen as market models. However, in July 1997 the so-called 'tiger economies' experienced a post-war Depression. Author Naomi Crane noted in "The Militant" that the Asian turmoil started in Thailand with the devaluation of its currency, the baht. By the end of August of the same year, there was a plunge in the Malaysian, Thai, Indonesian, Philippine and Hongkong stock markets from as high as 11% to 8%. David Sanger's New York Times article entitled "The Overfed Tiger Economies" cited interesting improvements and economic changes in Asia. He expressed skepticism and sarcasm over the erection of the skyscraper in Kuala Lumpur, and the quick construction of infrastructure in Bangkok. He mentioned Thailand's satellite launch and construction of car plants and other mega-projects while expressing wonder as to the source of funding. It was said that East Asia was being supplied with enormous foreign investments amounting from $60 billion to $70 billion a year. The devaluation was caused by the fact that baht was being sold at high fixed rate against the US dollars, enough reason for the Thai government to run out of foreign exchange reserves. The consequences include scarcity of capital, devaluation of the baht, and an increase in interests on debts. The slump in Thailand's productivity and the increase in unemployment rate affected exports and with the ripple effect, it affected the neighboring countries. The paper "The Asian Crisis: Causes and Cures" revealed The International Monetary Fund's (IMF) position that the success of these tiger economies encouraged huge foreign investments, stricter demands on policies and financial markets that were difficult to keep up with. Indonesia, South Korea and Thailand were the countries most affected by the Asian economic recession. The economic growth of Indonesia slowed down from an average rate of between 5% and 7% to 4.7% in 1997. Forecasts for 1998 and 1998 showed a negative 12% growth, and inflation rate was predicted to soar to 66%. In 1998 rupiah's value declined by 80%. As a consequence of the devaluation, the country's foreign debt multiplied.. Simple economic theories would explain how the devaluation of baht affected other economies. A devaluation of any local currency implied an increase in the cost of imports. Crane stated that in Thailand, such devaluation meant inflation in fuel and food. Reports said that overall prices soared 4.9 percent in July 1997 from the previous year. The surge in rice and flour prices was even higher, at 42%. In the Philippines, interest rates reached 33.5 percent in September 1997 from the previous week's 12 percent. This was for the peso to sustain its value or at least slow down its decline. Inevitably, interest rates on credit cards, mortgages and personal loans would also increase. Malaysian Prime Minister Mahathir Mohamad blamed the IMF for the economic decline. He believed bracing the stock market with public pension money would resolve the issue. Martin Hart-Landsberg and Paul Burkett's "Economic Crisis and Restructuring in South Korea Beyond the Free Market-Statist Debate" offers an analysis of the causes, nature and consequences of the restructuring process of post- Asian crisis South Korea. In the process of identifying the causes, the authors discussed the various aspects of restructuring and reform. The article studied the cause of the country's monetary decline from two standpoints: the neo-liberal position and the statist position. According to the neo-liberal view, corrupt investment and support of chaebol caused the slump. It suggested that in order for South Korea to recover from the financial doldrums, nationalistic industrial policies had to be abandoned. It also favored corporate downsizing, transparency in accounting, and a more active participation of foreign funding in establishing economic activity. The statist view believed otherwise. It held that the government industrial policies at the time worked positively for the national economy and that the problem was not due to overregulation but rather, to underregulation, thus canceling out the free-market position. In any case, both views worked on the assumption that capitalism was an effective way to achieve development. In the same paper, Hart-Landsberg and Burkett offered a rather radical view of South Korea's crisis and strategies for economic. They argued that neither market liberalization nor deregulation could answer the Asian problem and suggested that what the economy needed was a community-led socialization of the chaebol and government sector, coupled with cooperative-democratic decision-making mechanisms. While analysts perceived working-class resistance to capitalist restructuring as questionable, both authors believed that such struggles meant advancement to democratic socialization This paper focuses on the situation in South Korea during the Asian crisis. Pre- Asian crisis South Korea was the 10th largest economy. To emphasize how much it has developed since then, its gross domestic product per capita after World War II was comparable to Africa and some poorer Asian nations. Its progress was an absolutely huge economic leap. There was a close relationship between the government and businesses, small and big industries received support from the government and assistance from the labor department was available. The South Korean government was successful, with its promotion of raw material importation and steps taken to draw in savings and investment over consumption. When the crisis hit the economy in 1997, monetary growth deteriorated. Later on, the economy fluctuated. Some critics believed that the existence of chaebols aggravated the dwindling economy. Chaebols are government-assisted and family-controlled conglomerates such as Hyundai, Samsung, Daewoo and LG that took roots after the Korean War. Some believe that the stronger the chaebol, the greater the corruption and cronyism. Chaebols and banking were so closely linked that administration and regulation were inefficient and the use of capital was not optimized. The banks owned by chaebols , say merchant banks, were less regulated than commercial banks. In general chaebols were aggressive in their expansion efforts; however, they were not sufficiently rigid with financial supervision. At some point, the debt/equity ratio reached 500 percent as a consequence. Contrary to the claim above, the government held its faith in chaebols because they responded to government's efforts and initiatives. According to Hart-Landsberg and Burkett, once the government identified the key industries to tap and which products to produce, it assigned a chaebol to implement the project and carry out the production. Restricted by government policy, a chaebol would create a number of subsidiaries that had their respective presidents but were still under the direction of one chairperson, the head of the chaebol group. Such structure was liberating for the chaebol since it was able to expose itself to local and international markets and expand itself into other industries . The negative side to this as far as Korean government was concerned was that once the chaebol used its power and ability to penetrate other markets it would threaten other economies which could lead to their withholding of major products from chaebol exporters. Suk H. Kim's "Asian Financial Crisis of 1997" which appeared in Multinational Business Review identified a number of causes of the Korean financial turbulence. Kim mentioned the artificially high levels of the Korean currency won, the government-directed banking systems and financing schemes, crony capitalism, enormous investment backed by excessive borrowing, lack of transparency in accounting, amendment of labor policies and the incongruence of assets and liabilities in the banking industry. The author also mentioned the misallocation of capital and human resources as an additional cause of Korean financial woes. Jahyeong Koo and Sherry Kiser in "Recovery from a Financial Crisis: The Case of South Korea" claimed that compared with that of other Asian countries, the effect of the economic decline was more profound in Korea. Despite that, South Korea was the fastest to cope with the challenge and recover. With foreign borrowing to foreign exchange reserves of almost 3:1, it far exceeded other countries. Thailand and the Philippines had 135 and 105 percent ratio, respectively. The huge ratio came as a result of Korea's incentive offerings to local banks and large private firms to loan foreign currencies for industrial development. Now the problem lay on the fact that the foreign borrowings were short-term while the domestic offerings were long-term. This inconsistency ended up in maturity mismatches. Economic analyses blame corporate governance practices for the downward trend. The founders' families dominated the decision-making process. The outcome revealed managerial incentives that increased size and market share at the expense of shareholder value. Logically, government-directed banking systems created fragile banking structures. The close relationship between the government and the banking sector created some mentality that resulted in aggressive decision-making and risk-taking, over-investment, low profits and lack of foresight. A chronological enumeration of the major events related to the financial distress in the region appeared in Koo's and Kiser's article. In May 1997, speculators attacked the baht. A month later Thailand declared a managed float of the currency and the International Monetary Fund supposedly came to the rescue for technicalities. Indonesia left its managed exchange-rate regime a month after. It was in October 1997 that the Korean won marked its abrupt depreciation. Before 1997 ended IMF granted South Korea a $21 billion loan and by the beginning of the 1998, the country and its creditors had worked on loans' payment scheme. Short-term debts amounting to $24 billion were traded for new loans with one- to three- year maturity dates. One-third of the merchant banks closed down. In February 1998, labor laws were amended to legalize the utilization of temporary workers. A few months later Daewoo, one of the top chaebols, was dismantled by the government. In anticipation of the collapse that the move was to bring about, a commercial paper market stabilization fund was created, raising $24 billion. President Dae-Jung Kim officially announced December 1999 to be the end of the financial crisis. Around the early part of 1998, the IMF donated $36 billion to make possible reforms in Indonesia, Thailand and Korea in order to contain the economic damage caused by the crisis. However, this caused declines in currency and stock markets, aggravation of the situation and a sharp increase in foreign debt. One of the lessons learned from the Asian market crisis was the need to strengthen the banking sector in order to maintain a health financial system. Shalendra Sharma's article "Stability amidst Turmoil: China and the Asian Financial Crisis" explained how a sound banking system could help evaluate and check the risks and returns on monetary intervention, including the appraisal of creditworthiness and enforcement of financial contracts, loan recovery and procurement of collaterals. A number of drastic changes were implemented to encourage infusion of foreign capital into the country. In an interview on private equity trends, Sanghoon Lee revealed Korean government's opening up to foreign investors. The rules that once hindered foreign participation and restricted investors from business acquisition and purchase of publicly traded stocks were made lax. It used to be that government approval had to be sought before such ownerships were allowed. This liberalization allowed the achievement of one of the most mature private equity/M&A markets in Asia. Korea's banking sector was able to come up with complex financial sponsorships - something that came as an accomplishment in complex structures since not many countries could have offered the same scheme. Regulations that permit the establishment of domestic private equity funds were introduced recently. The entry into the market of global funds and domestic funds raised concerns about increase in valuations that might need for financial sponsors to compromise on documentation and execution agreements. Another cause for worry was the possibility of regulations' failure to keep up with the various market developments. In this case many speculations arose, such as that it would be difficult for investors to get in leveraged deals because of existing offer rules and that government's involvement in the approval process would complicate deals. Researchers proposed financial-crisis models as long-term solutions for South Korea and as tools to forecast economic conditions. There were two models: the weak-fundamentals view and the financial-panic view. Based on the weak-fundamentals perspective, a country's weakness in macroeconomic or financial fundamental triggers the abrupt backflow of capital. This called for radical reforms and support to see things through. On the other hand, the weak-fundamentals view predicted a slow recovery because it took a while before creditors and other financial institutions were able to complete the auditing and accounting process and recognition of losses was not made instantly. However, economists claimed that neither of the two views above proved helpful in the Asian-crisis recovery. Instead of going by the policy of the weak-fundamentals view, the Korean government controlled the finance sector to keep the country's credit system intact while undergoing structural reform. Much of Korea's recovery from the economic recession was due to alternative funding and labor adjustments. One of the propositions for growth was the establishment of a more inclusive governance system which accommodated some cooperation between the chaebols and the government. It facilitated the decision-making surrounding planning, economic policy, industrial policy and certain aspects of the safety net policy. Intent on joining the global market, South Korea restructured its economy. According to economists, Korea realized that the chaebols could not focus on their main strengths and the banks could not concentrate on corporate governance without a market-oriented social and political environment. With the globalization of production, markets and information, a state-capital dependency emerged. Capitalist state undermined the policy autonomy of the state. It prevented the state from achieving its socially directed goals of full employment, education and health. The fast recovery of Korea since the economic recession misrepresents the observed social and political developments. The election of Kim Dae Jung to power symbolized the bureaucracy's adoption of a politically neutral institution. The state has manifested social maturity by valuing loyalty to the institutions of governance as opposed to loyalty to the institutions of the few privileged groups. Works Cited Craine, Naomi. The Militant. 6.31. 1997. 20 Dec. 2005. http://www.hartford-hwp.com/archives/50/006.html. Hart-Landsberg, Martin and Paul Burkett. "Economic Crisis and Restructuring in South Korea: Beyond the Free Market- Statist Debate." 33.3. 2001. Critical Asian Studies. 20 Dec. 2005 . Kim, Suk H. "Asian Financial Crisis of 1997." Find Articles. 20 Dec. 2005 . Koo, Jahyeong and Sherry L. Kiser. "Recovery from a Financial Crisis." Pages 24-26. 20 Dec. 2005. . Sanger, David. "The Overfed Tiger Economies." New York Times. 1997. 19 Dec. 2005 . Sharma, Shalendra. "Stability Amidst Turmoil." Harvard Asia Quarterly. 2001. 20 Dec. 2005. . Read More