Lessons from Korea’s financial crisis
By Jeffrey Jones
Former AMCAM Chairman
The Asian financial crisis of 1998, which started in Thailand and quickly spread throughout Asia, engulfed Korea with an overwhelming losses and a sense of despair. The excessive leverage brought about by control of the financial markets by the political apparatus resulted in tremendous losses to the financial system and a need for deep and broad restructuring of corporate Korea.
The Korean financial system was on the brink of absolute failure. The International Monetary Fund (IMF) was asked to provide a bailout package as Korea had run out of foreign exchange and was facing a moratorium on remittances.
The bailout came with tough conditions and advice from the experts at the IMF and World Bank, among others, on how to restructure the Korean economy. This was a bitter pill for Korea to swallow as it meant following market principles of transparency in respect of the economy and the end of government controlled economy and directed lending to the large groups.
The advice was clear. No company was too big to fail, and the financial system had to be propped up in order to protect depositors and prevent a collapse of the economy. The Korean government showed remarkable courage in accepting these recommendations, and implementing the necessary reforms and restructuring of the economy.
The Korean government invested more than one hundred thirty billion dollars in the financial sector to prop up failing banks and the government paid back the IMF loan ahead of schedule. The amount of the government bailout package seems miniscule in comparison to some of the packages seen most recently around the globe, but at the time, it was significant.
Unlike Japan which failed to implement any real reforms of its economy, Korea moved quickly to adopt reforms. The government ended the control of the banks, adopted market principles in the regulatory regime and essentially opened the markets and created a transparent Korea.
All regulatory problems were not fixed, but by and large Korea followed the advice of the experts and created a market-based economy in which no one company was able to gain preferential access to loans or other favors based upon political connections.
Korea implemented massive deregulation that opened up the economy to competition, both internal and external. Companies were restructured and unemployment soared breaking the decades long social pact that companies would be supported by the government if they stayed on the right side of politics and employees would not be laid off.
The debt outstanding in the bankruptcy of the Daewoo Group, for example, exceeded $60 billion and Korea was left with only 12 or 13 large group companies from what had formerly been 50 chaebol regulated as large business groups by the Fair Trade Office. No single company was immune from the restructuring and all businesses in Korea suffered significant losses in assets and value, reductions of their work force and many simply faded away.
This new relatively deregulated and transparent economy has served Korea well the past ten years. With stronger balance sheets, improved transparency and a focus on profitability rather than growth, Korean companies were able to withstand the latest crisis originating in the U.S. and Europe.
The Korean economy has recovered faster than other OECD economies and Korea has much less to do in the area of financial reform than other economies. There are adjustments and changes that Korean still needs to make, but Korea has maintained a careful balance of permitting greater growth in the financial markets while controlling systemic and institutional risk.
As nations begin the process of preparing for the upcoming G-20 in November, they would do well to look at the Korean market and the policies that have been followed by the politicians and regulators in regulating the financial markets in Korea.
While the market participants feel the restraint on growth is at times excessive, they also recognize that the regulatory regime has also prevented the massive losses experienced in other markets.
The initial signs coming from the U.S. and Europe point to an excessive desire to restrain growth for the sake of financial stability. Thus far, Korea has resisted this temptation opting to permit growth without excessive risk taking. Hopefully, the G-20 and others who are looking to change their systems will take a clue from the Korean market as to the correct balance between growth and stability.