Supplying capital to real economy key to prosperity

By James Rooney

Seoul Financial Forum Vice Chairman

Over the last thirty years, the financial systems in many developed countries have been undergoing profound changes driven by innovation, relaxation of regulatory constraints, and greater global economic and financial integration.

The benefits have undoubtedly been to create wider and deeper funding of real economic activities, increased economic efficiency with capital as the catalyst, and greater rewards to providers of capital and the intermediaries who can attract them. Natural consequences of these changes have also been greater complexity, increased systemic risk, and the breakdown of regulatory oversight and traditional corrective mechanisms.

Over the last two years, many of these consequences have come violently to the surface, erupting like unfriendly volcanoes, particularly in the United States, and the U.K., and individual economies have found themselves overexposed and overleveraged.

And it is fair to observe that for some countries, 2010 will not represent the end of the process, nor even the beginning of the end; for many, it is only the end of the beginning. As new corrective mechanisms are put in place, and tougher regulatory regimes are implemented with increased capital requirements and reduced financial freedoms, it seems inevitable that further capital and liquidity will be sucked out of many markets, particularly in the U.S. and Europe.

Lost decade

It is also possible to imagine that the necessary domestic financial and budgetary adjustments that now face many developed countries could lead to a "lost decade" of weak growth and missed opportunities for those countries.

But not all countries have been equally careless in the development of their financial sectors, and not all countries have overexposed themselves to excessive leverage, whether at the individual, corporate, or government level.

China is clearly a separate case from the rest of the world, powering on with extraordinary economic growth even while have to make a dramatic transition on the fly, shifting from an export-oriented economy to a domestic consumption-driven economy as its export partners suffer the direct and indirect effects of the global crisis.

And interestingly, Korea is also far better positioned today than many other developed economies. Having experienced a separate financial crisis of its own in 1998, Korea's corporations are probably in better health today than at any time in history, with low debt, high liquidity, and strong earnings.

Korean households have never had the freedom to over-leverage their homes in the capital markets, and still retain substantial equity in their real estate assets.

And the Korean government has always preferred to run a balanced or surplus budget, so government borrowing is still well below global benchmarks, with public debt at 28 percent of 2009 GDP and foreign exchange reserves of over $278 billion, ranking number six in the world. And Korea, like a little ballerina dancing on top of a huge elephant, has the proximity, the ability, and the opportunity to engage with the Chinese economy in ways that no other advanced country can do.

These strengths for Korea at a time of global weakness represent a unique opportunity to advance as a leading developed country just as western countries become compromised by their challenges of the past and are unavoidably distant from the new growth engine of the world economy in China.

The challenge for Korea today is to rise to this new opportunity and capture the benefits that it can represent. Korea has clearly done well in many manufacturing industries, even more remarkably given its absolute lack of raw materials and energy supplies.

But its service sectors now need to show that they can successfully compete on the global stage, and the most prominent opportunity is in the financial sector. The key, though, is for finance to focus on directly supporting and funding real economic activity, and avoid being attracted to the siren songs of complex financial instruments or business models that do not create new products, goods, and services that people actually want to buy and use.

Korea has an abundance of capital and the ability to generate more, with its high domestic savings rate, increasingly large pension funds, and continuing innovation in infrastructure funding. But it still needs to solve the age-old problem of how to support small businesses, and to learn how to successfully fund and develop long-term projects that will create tourist destinations and the advanced services industries of the future.

Remaining focused on supplying capital to the real economy is the real key to growth and prosperity, and it has served Korea well for the last fifty years. It no longer matters whether those investments are in Korea or around the world, but it has always been important to do it wisely and never lose respect for the financial "laws of gravity."