The Political and Economic Transition in East Asia

Strong Market, Weakening State

Xiaoming Huang

• Publisher: Routledge
• Year: 2013
• Topic: Social Sciences
• eBook ISBN:
  9781136114588
• Subtopic: Ethnic Studies
• Index: Social Sciences

The book examines the political and economic developments in East Asia since the end of the Cold War in an attempt to identify a broad pattern of transition, particularly in terms of the reshaping of the state's relations with forces and institutions in economy, politics and domestic- international interactions. The chapters are organised into three parts: I: The state in the new economy; II: The state in the new politics; III: The state in the new global environment. The contributors find a general pattern of the state's withdrawal from these three areas. But it is not simply that the market takes over, as some envisaged. Instead, the transition is moving towards a set of governance-producing arrangements in which the role of both the market and the state are appreciated. The book concludes that a more sophisticated approach is needed to the problems of development vs. governance, the state vs. the market, and global dynamics vs. national interests, for a better understanding of the dynamic transition and the consequent new political economy in East Asia.

PART I

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The New Market Conditions

CHAPTER TWO Kwan S. Kim

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Market Liberalisation and the Problem of Governance in South Korea*

Introduction

The financial crisis that erupted in Thailand in mid-1997 led in no time to the sharp decline in value of currencies, stocks, and other assets in a number of AMCs, including South Korea (hereafter referred to as Korea), disrupting the financial systems and real economies of these countries. For Korea, large contractions in economic activity have been accompanied by soaring numbers of unemployed and homeless. The current crisis unfolded against the backdrop of the miraculous performance that had registered an outstanding average annual GDP growth of 8.6 per cent over the preceding three decades. While Korea’s success has in the past been acclaimed as a model of the ‘developmental state,’ neoliberal economists today see the current crisis as reflecting the legacy of state governance. It is now argued that in the context of the contemporary global economy, the state should do less where markets work and focus only on improving the climate for enterprise and competition, in opening the economy to global markets.

This chapter takes a look at the dynamics of the new market economy in Korea and how they affected the Korean state’s efforts to overcome its past legacy of statist development while at the same time maintaining continual economic growth. It will argue that market liberalisation is a powerful force that redefines the nature of the state’s functions and redirects its involvement and activities. However, market liberalisation does not necessarily force the state out of the game. Rather it pushes the state into its proper position for safer and effective management of reform and development.

To make its case, this chapter will first briefly recount the condition of the market under the developmental state in the recent history of Korean industrialisation. It will then focus on the new market conditions brought about by the reform programme of the government and global economic changes, dramatically showcased in the recent economic crisis of 1997-98. It will further examine policy adjustments and the deepening of the reform programme by the government in response to these new conditions. The chapter will conclude by looking at the new relations the market demands to have with the Korean state.

The Market Under the Developmental State

Korea, well into the 1960s, represented a truly backward economy based on a subsistence agriculture. Its per capita income in 1961 was $82 (in 1960 prices), which then placed the country below those of Haiti, Ethiopia, Peru, Honduras, Yemen, and about 40 per cent below India’s. The country in the immediate post-Korean war period was an economic ‘basket case’. It relied on foreign aid for sheer survival. Undisciplined capitalism during this period had done very little for development.

Beginning with the military coup in 1961, the country’s economy began to make a dramatic turnaround. In two decades, the country’s real per capita income more than tripled, placing Korea in the top third of all middle income countries. By 1996 Korea, with its 42 million population and per capita income of over US $10,000, emerged as the world’s eleventh largest trading nation. In 1992 a civilian president was elected, for the first time after three decades of authoritarian regimes. Externally, Korea began to play an active role in global affairs by joining the World Trade Organization (WTO) and the Organization of Economic Cooperation and Development(OECD) in 1996.

Behind this transition to a modern economy has been the complex and subtle evolution of a state-managed economy. Guided by the belief that a well-managed, state-led economy would function better than one based on unfettered market forces, the state’s active role in development evolved in the early stage of industrialisation. Korea had what Myrdal referred to as a ‘hard state’, whose interventions focused on the development of areas of the economy perceived to have a longer-term potential. Korea’s authoritarian state pursued pragmatic approaches to industrialisation, accommodating market forces only when they were seen to work. The market system did not serve as an organising principle of the economy but as an instrument in attaining the national goal of industrialisation. Korea’s rapid industrialisation owed itself to the developmental state role played by its government and has been extensively documented (Amsden 1989; Chang 1993; Wade 1995; Kim 1997a).

Over the longer term, nonetheless, the developmental state strategy paved the way to structural imbalances and distortions and sowed the seeds, eventually, for the financial turmoil in 1997. The centrepiece of the strategy was industrialisation via export promotion. An extensive system of industrial targeting was introduced in which a set of promising export industries was chosen for government support. The most important means of supporting the targeted firms was the allocation of financial resources by the state. While high-leveraged financing for targeted firms relied heavily on the state-guaranteed external borrowing, the domestic banks were restricted in credit decisions by government regulations, and were required to hold large amounts of monetary stabilisation bonds which paid below-market rates. This practically inhibited the development and growth of interbank money markets and established a centralised banking system.

As all the support and incentives were to be given to those firms in the targeted sectors, the large conglomerates in Korea, known as ‘the chaebol,’ received the lion’s share in subsidised loans. Large-scale enterprises, able to capitalise on scale economies in production, were in a better position to outbid smaller firms in government-financed projects. This practice of ‘policy loans’ not only led to a rapid rise in industrial concentration but also rendered Korea’s corporate sector and the economy, vulnerable to external shocks and financial instability.

As bankers complied with government guidance in credit allocation, they placed a trust in the state’s unspoken guarantee of bank loans. They became lax in examining loan applications, particularly from large conglomerates, and extended loans indiscriminately for profitable but risky ventures. While bankers did not take very seriously the risk factor in lending, the centralised economic systems in Korea created patron-client relations between the state and the corporate sector – a kind of crony capitalism. The chaebols cultivated a symbiotic relationship with the government, which could help them out if something went wrong with their investment. The Korean state’s intervention in the financial sector resulted in the problem of moral hazard (Radelet and Sachs, 1998). The outcome was over-borrowing by the chaebols with their consequently unstable debt-equity position, and the rise in external debt for the economy.

By the late 1970s it was not uncommon to find the chaebols having liabilities five to ten times as high as their own net worth. Burdened with excessive interest payments in relation to their equity, they became increasingly vulnerable to changes in economic conditions and external shocks. Their operations were rendered precarious, particularly in bad times when the economy was in a downturn, as was the case in the early 1980s. By the end of 1996, the average debt-equity ratio of the top 30 chaebols reached 400 per cent, which was twice the international banking norm of 200 per cent. When Korea joined the OECD in 1996, it further encouraged capital inflows by opening its financial market. The domestic banks, mainly merchant banks, heavily imported foreign capital, mostly of short-term maturity. The cumulative external debt rose from $42 billion in 1992 to $157 billion in November 1997, the eve of the crisis. Significantly, almost 90 per cent of the debt originated from the private sources of merchant and commercial banks.

The debt issues aside, it is worth further noting that the industrial targeting policy of the past three decades has led to serious structural imbalances and distortions in the Korean economy. The past targeting approach specified only which sectors of the economy should be promoted for expansion. Loans tended to be approved on the basis of superficial compliance with the administrative guidelines and not on the merits of individual projects. Many worthwhile projects failed to be undertaken.

These weaknesses were manifest as early as in the late 1970s, when a number of government-supported projects had to be discarded. Too many production units were crowded into a few sectors, resulting in overcapacity of these industries. On the other hand, the borrowed money was all too often lavishly invested in speculative real estate markets and other unproductive non-tradable activities. Korea’s developmental state also rewarded successful exporters by basing support on the quantitative results of their exports. This policy not only resulted in an economy-wide inefficiency in resource allocation, but also created a structural imbalance biased against the development of domestic goods industries. Moreover, such a support system has favoured the production of assembly-type exports which rely heavily on foreign raw materials. This has led to the need for more imports through exports with a consequent chronic pressure on trade balance.

In summary, Korea’s past strategy for growth maximisation led to serious structural distortions and imbalances, as reflected by the syndromes of business concentration, stagnant productivity, fragile corporate financial structure, corporate bankruptcies, and tenuous inter-industry linkage. The market was simply marginalised and subordinated to the state’s developmental rationale. The Korean state’s failure to reform the flawed industrial and financial systems, in preparation for global economic integration, turned out to be the major, structural cause of the current crisis.

The New Market Conditions as Crystallised in the Financial Crisis

Korea entered the current crisis under a reasonably healthy macroeconomic with a balanced budget, high savings, and low inflation rate. Few scholars expected that the financial turmoil which erupted in Thailand would so quickly spread to a country like Korea, whose economy, until the eve of the financial meltdown in November of 1997, had been perceived by international creditors to be ‘fundamentally sound’ (according to then IMF Managing Director, Michel Camdessus). Indeed, well into late 1996 Korea’s trade deficits, as shown in official statistics, had also been below the manageable level of 5 per cent of GDP, which did not seem to be of concern to policy-makers.

Beneath the seemingly placid surface, however, the Korean crisis had for some time been brewing and the country’s external balance began to deteriorate beginning late in 1996. By mid-1997 Korea had a serious problem with its external debt which, as already noted, rapidly rose as a result of cumulative trade deficits. The total external debt, before the Korean government’s request for the IMF bailout, was more than five times the country’s useable foreign exchange reserves that shrank to $30 billion. Moreover, the financial structures of the Korean corporate sector were over-leveraged by relatively short-term debts.

With the breakout of the ASEAN turmoil that erupted in the summer of 1997, it was simply a matter of time before investors would lose confidence in the Korean financial market and begin withdrawing investment funds out of Korea. The country found itself unable to defend the value of the Korean won at the time of capital flight. It could not secure new funds from international markets nor could it have maturing loans rolled over. Foreign capital continued to be withdrawn. The domestic stock prices plunged and the exchange rate soared. Concern about the continued depreciation of the won, foreign as well as domestic investors panicked and fled the stock market, creating a vicious circle of plummeting stock prices and further devaluing the won. The nation plunged into a full-blown financial crisis involving real-sector adjustments. What started as a liquidity problem soon turned into a triple crisis involving balance-of-payments, financial and corporate governance.

In retrospect, the causes of the crisis can be attributed to the deep structural factors both internal and external in origin, which provided a fertile ground for the crisis to erupt. Chief among them is the legacy of structural distortions and weakness inherited from the past industrial policy. More direct external causes can be found in the unfavourable international developments after the mid-1990s when the health of the country’s trade was severely eroded. More significantly, the poor governance of the economy under Young-Sam Kim’s (YS Kim) civilian regime was another contributing factor.

As for the structural causes, unlike the debt crises elsewhere in the developing world, the snowballing rise in Korea’s external debt after the mid-1990s resulted from the microeconomic problems of low performance and profitability of domestic firms – especially of the chaebols. As already noted, at the root of the problem was the clientelistic state-business relationship inherited from past industrial policy. The Korean government relied excessively on the chaebols for export success and the latter, in turn, had privileged access to government subsidised credit. The chaebols, on the other hand, accustomed to rapid growth and believing that they were too big to fail, became overly ambitious in their investment decisions. External borrowing undertaken during the boom years in the early 1990s alone caused the short-term debt to reach almost $100 billion or about one third of GDP.

Business clientelism was reinforced by Korea’s deeply flawed financial systems which operated under the presumption of an implicit bailout policy by the state. This expectation led to imprudent lending by bankers to meet the chaebols’ excessive demand for credit. Imprudent lending continued, despite the rise in the banks’ non-performing assets, as the asset-market bubble introduced in the late 1980s began to burst in the 1990s with Korea’s declining exports. Korea’s highly centralised banking system lent it to frequent political interventions on behalf of the chaebols. Imprudent and undisciplined borrowing led to over-investment in the sense that too many investment projects were undertaken which turned out to be not very profitable. As profit margins at the enterprise level became increasingly narrower, the business sector was rendered potentially more vulnerable to any unanticipated shock (Graham 1999).

This explosive situation was exacerbated by unfavourable external developments after the mid-1990s when Korea’s export expansion slowed down from the annual growth rate of 33 per cent in 1995 to that of 3 per cent in 1996. This resulted in the drastic rise in Korea’s current-account deficits and external debt, as indicated in Table 2.1. Among the factors contributing to Korea’s growing trade deficits were the collapse of Korean export prices and the loss of c...

Table of contents

• Cover
• Half Title
• Full Title
• Copyright
• Dedication
• Contents
• List of tables
• List of figures
• List of Abbreviations
• List of contributors
• Preface
• Introduction
• PART I: The New Market Conditions
• PART II: The New Political Conditions
• PART III: The New State-Market Nexus
• PART IV: The New Global Conditions
• Conclusion
• Appendices
• Bibliography
• Index