South Koreas Financial Crisis - Coursework Example

South Korea’s Financial Crisis

Introduction

Financial crises are rampant problems that are more common than not. The issue does not discriminate against well-off and badly-off nations. Since immemorial, powerful nations such as the United States of America, German, Britain and France have faced this challenge, after losing a famous financier or engaging in lengthy warfare that drained their key financial bases. In the contemporary world, the menace is quite common and manifests itself in different ways that affect varied aspects of the economy. This usually translates to the cost of living and doing business within the affected country. During the 1990s, Asian countries such as South Korea, Thailand, and Indonesia simultaneous experienced economic challenges triggered by the Chinese financial crisis. South Korea was probably the worst hit by the wave. However, its recovery remains mysterious to many people, to date. The fact is that South Koreans worked hard and toiled for the sake of the country to improve. Similarly, the International Monitory Fund (IMF) played a central role in the recovery process.

Causes of the Crisis

A number of factors were critical in ushering the South Korean Currency Crisis. Each of the factors came prior to and shortly after the crisis. These factors include government interference with the allocation of resources, structural problems, rapid wage increase, asset inflation, misguided corporate incentives and erosion of corporate profitability, overvalue of the exchange rate and Capital Market Opening, and the Increased Term Mismatch. Seemingly, the country was operating in line with Keynesianism economic theory principles; the economic proposals of John Maynard Keynes, argued that the government should be in control of monetary and fiscal programs in order to create employment and stimulate business activities. However, this theory often leads to market manipulation and thus almost impossible for it to self-correct in the even that a crisis arises.

Government Interference with Allocation of Resources

There were extensive moves by the government to control assets of production. This saw the regime spurring domestic entrepreneurs with cheap credit, export incentives, and other related measures aimed at protecting and empowering them (Allegret, Couharde, & Mignon, 2013). Until the late 1990s, the government was the sole owner of major commercial banks, and thus it controlled their management and credit management process. Since many firms enjoyed government support and empowerment, they became careless, could condone some levels of liabilities, and experienced political influence. This led to management failure and consequently did not operate economically. As was the case, the government could easily bailout such firms before they collapsed, after financial mismanagement. This promoted the firms’ ambitious and reckless investment plans, because their woes were always socialised.

Furthermore, the South Korean Government kept external investors away as it entertained local investors with taxpayers’ money. For instance, by 1998, corporations received subsidiaries amounting to 43 per cent of their expenditure, according to Fair Trade Commission of South Korea. This made it impossible for the country to regulate and manage the socializing effect of their influence. Without the capitalization influence that external investors could bring in, the country was slowly inviting the financial crisis.

Structural Problems

In 1990, South Korea suffered a series of structural problems affiliated to the financial sector. This was as result of the distorted incentive landscape fuelled by the encouragement of overexpansion of corporate investment, distortion in resource allocation and reduced export competitiveness (Cesaratto, 2017). One of the key contributing structural issues was democratisation. Initially, South Korea had almost similar administrative set up as that of North Korea, which can either be defined as dictatorship or moderate autocracy. When the country dressed the democratic attire, trade unions emerged with a predetermined force. Increase in bargaining power led to increases in wages, prices of services, and real estate cost. The Chaebol (multinationals and related entities) increased their social influence at the expense of investing profitably. The outcome of this episode was nothing but amplification of interest rates, wages rose faster than productivity, and supervision to curb reckless lending by financial institutions failed, which led to financial crisis in South Korea.

Rapid Wage Increase

Uncontrolled escalation of wages was elemental in South Korea financial crisis because domestic wages grew faster than labour productivity. The act resulted in increasing suffering from the declining competitiveness and profit on the side of the corporate sector (Jahjah, Yue, & Wei, 2013). This problem had not surfaced until in the 1990s when wages began to take a lion share in many exporting companies, an act that made them incur untold operational deficiencies. In the first three months of 1989, there were more than 300 industrial actions in South Korea. President Roh Tae Woo had to increase real wages by 70 per cent in less than three years.

Asset Inflation

The period between 1988 and 1998 saw an increase in prices of major assets in South Korea. When factors of production increase in prices, the products must be expensive. Overall inflation rate was increasing at the rate of 6.57 per cent until in 1998 when IMF intervened. The land was one of the most expensive assets within the specified decade. This resulted in high rental income and cost of living (Jahjah, Yue, & Wei, 2013). Workers living in urban areas pressed their employers for an increased salary that could match the high demands of buying food and paying rent. Increase in estate prices was a clear indication of escalation of asset value of corporation, which expanded more quickly than their operational sales deficit. This made companies within the country keep on borrowing money to sustain worker wages, and other operational expenses. The government was also ready to offer credit facilities to such corporations. It was ironical that in spite of deficits of many years, companies continued to sustain investment growth without running bankrupt.

Misguided Corporate Incentives and Erosion of Corporate Profitability

As earlier noted, major corporations were government owned and incentives kept on flowing in them even when they made less or no profits (Kim, 2017). Rivalry among companies motivated them to investment move. Whether corporations made losses or profits, they were under the serious protection of the government. Many managers in the corporations were government agents who worked hand in hand with the political fat cats. By 1994, many corporations operated with 85 government bonds guaranteed by banks.

Giving incentives heedlessly to companies kept on draining the state finances instead of raising surplus cash that could be injected in the cash flow system (Kim, 2017). Foreign investors were kept at bay to avoid competing with the government-controlled companies. There was relaxation, recklessness, mismanagement, and embezzlement of government funds in state-owned corporations. It is against this backdrop that the corporations could not make any meaningful profit and the little they made, in most instances, was unaccountable. Instead of raising proceeds to the government, the corporations acted as liabilities, draining funds away from government accounts. By the end of 1998, South Korea had $ 42 billion in nonperforming loans, representing about 17 per cent of their total outstanding debt.

Exchange Rate Overvaluation and Resource Shift towards the Non-tradable Sector

The export sector suffered from low receipts and high factor costs contrary to the non-trade (Jahjah, Yue, & Wei, 2013). For instance, the manufacturing sector, which was the prime mover of South Korea economy, became less important in 1990. Workers in the sector decreased while those in the service sector such as retail, wholesale, and entertainment businesses increased rapidly. Just to highlight, the number of workers in the catering and retail sectors in 1996 was 28 percept while those in manufacturing sector only 7 per cent, a diametric measure to what happened in developed nations like Germany, China, Singapore, and Japan.

Resolution and Intervention

For the country to change from its status quo, it had to adopt a different economic system. South Korea replaced Keynesianism with liberalism, which allowed a free market system with competitors and consumerism, which inspired creation of more markets both locally and internationally for the already manufactured products.

It took enormous efforts for South Korea to escape from its financial trap. First, the Koreans had to toil hard. As earlier reported, the financial crisis was a wave among Asian countries. However, the only thing that distinguished South Korea from other countries undergoing similar predicament, was the hardworking and patriotic nature of the Koreans (Pascha, 2010). They sacrificed individual comfort for the greater good of their nation. They embarked on spending less and saving more and upgraded their skills to ensure the country remained competitive in almost every sector of production.

From their historical narratives, generally, Koreans believe that things get worse before getting better. Thus, they prepared for the same sentiment by endorsing the harsh economic reforms that the government undertook. The support of the hard policies was not easy. For instance, during the laying off of workers as outlined in the Labour Standard Act, more than 1.7 million South Koreans lost their jobs. The ones who retained theirs worked twice hours to produce more (Pascha, 2010). In 1998, the government employees agreed to give 10 per cent of their salary as a path to create funds to those who lost their jobs.

Immediately IMF announced bailout, the government nationalised two of South Korea’s Banks, Seoul Bank and Korea First Bank instead of letting them fade away (Allegret, Couharde, & Mignon, 2013). Several other national commercial banks were brought under the government stewardship. Through government bonds, the country was able to generate capital in global markets. The government issued a guarantee on all commercial deposits, an act that promoted investor confidence in the country.

IMF played a quite important role in lifting South Korea from her currency crisis. Its bailout worked miracles. The bank swiftly approved 60 billion dollars to be pumped into the South Korean economy in response to the crisis (Allegret, Couharde, & Mignon, 2013). Several other structural reforms followed. First, the government had to ensure transparency more so in the field of finance. This ensured no money was lost through dubious means. Secondly, the tie between the Chaebols and the government had to be broken. This was a tough decision as it made 14 family-owned corporations, which enjoyed government support, to become bankrupt. The government could not interfere with their affairs as it had earlier done. Bank debts had to be restructured. The government used the bailout money to write off the debts. The Korea Asset Management Corporation was forced to buy off most the accumulating bad debts as a way of delaying payment. This move also increased the working capital of the banks to open up the lending cycle and empower economic development. The IMF also advised the South Korean government to adopt a tight monetary policy with high-interest rates to prevent capital flight. This move worked significantly to stabilise the foreign exchange market.

Current Country Situation

From the year 2000, South Korea was busy matching towards its currency and economic stabilisation. Since then, the country has seen monstrous improvements in terms economic progress (Pascha, 2010). In January 2014, the country had 24,700,000 employees compared to 2012 when employment slots remained at 800, 000. In 2013, the hiring rate of those above 15 years of age was 1.3 per cent. This rose to 64.3 per cent in 2014. In September 2017, the employment rate remained at 61.3 per cent.

South Korea is counted as developed nation because it has per capita income of about $25,000, which is a bit higher more than that of Portugal ($21,000). It is also a member of Organization for Economic Cooperation and Development (OECD). Furthermore, its Human Development Index (HDI) is 0.898. Any country whose HDI is above 0.8 is considered developed. Just like in the U.S, poverty level in South Korea is mere 15 per cent (Allegret, Couharde, & Mignon, 2013). The point is that the country has made great efforts to rise from financial crisis and is in better condition today. There is no currency crisis in Seoul.

Conclusion

In summation, Currency crisis was a great challenge in Asian states in the 1990s. Being one of them, South Korea’s financial crisis was as a result of offering excess incentives to government-controlled corporations, increase in wages, high cost of production and less export of sale, among others. IMF played a key role in ensuring the country escaped from the financial menace. The citizens cooperated with government policies for the plan to materialise.