TCS Daily


A Job Half Finished

By John McKay - September 1, 2004 12:00 AM

It is hard for most outsiders to fathom just how much South Korea was affected by the trauma of the economic and financial crisis that afflicted the country in 1997-98. The statistics on this catastrophe are dramatic enough. After several decades of sustained growth, the Korean economy contracted by more than 6 percent in 1998, and only partially recovered in 1999. Unemployment rose from 2.6 percent in June 1997 to 6.9 percent in June 1998, and this is probably a serious underestimate. The value of the Won against the dollar was halved overnight, with disastrous results in the short-term. Non-performing bank loans suddenly made up 23 percent of the total.

But it was the psychological impact that was most important, and this continues to have an effect on public debate and policy even after the economy has made a recovery that is extremely impressive by most standards. Just as the inability of the Korean state to repel the colonial takeover by Japan in the early part of the 20th century resulted in a sense of intense national shame that is still deeply felt, so the crisis punctured the national pride that came from several decades of the Korean 'miracle'. There is now an acute sense of vulnerability, but coupled with a typically Korean sense of resolve that something so traumatic must never be allowed to happen again.

President Kim Dae Jung, who came to power just at the onset of the crisis, skillfully used these fears to push through a partial reform agenda in spite of a good deal of internal opposition. Much of value has already been accomplished in terms of restructuring many of Korea's ailing structures, but much remains to be done, and there are wide differences of opinion on the effectiveness of President Roh Moo Hyun in meeting the continued challenges of reform.

Part of the legacy of the crisis is that Koreans are generally much more cautious and pessimistic about the economy than are many outsiders. Growth is now running at around 5 percent, and is expected to be maintained at this level throughout 1995. The estimate of the current account surplus has now been upgraded to $20-25 billion thanks to booming exports, and foreign exchange reserves are at record levels. Yet the doubts remain. In the last two weeks two key economic policy makers have made very worrying statements. The governor of the Bank of Korea has raised the possibility that the country may be entering a prolonged period of recession rather like that experienced by Japan in the 1990s. Similarly, the minister of finance and economy, Lee Hun-jai, has complained about the lack of resolve among politicians to consolidate a market economy.

What these statements highlight is a clear split within the Roh government about future directions in economic policy. What is generally called the leftist group strongly supports policies that can improve the distribution of wealth, create more jobs and support the competitiveness of small and medium enterprises. Those on the right favor a much more market-oriented approach, of course, and a longer-term approach to building new financial and political institutions. These differences are causing real problems in policy development across a wide range of policies, and let me deal with just a few of the most important issues.

An intense debate is under way about the extent to which the government should be intervening to stimulate growth by pumping money into the economy. At the moment, fearing a Japanese-style stagnation in consumer demand, and keen to stimulate industrial investment, interest rates are low by Korean standards. However, this has resulted in a renewed real estate bubble, and the siphoning off of large amounts of money (sometimes illegally) for investment in property in the US.

Similarly, there is a debate about the appropriate exchange rate policy. The Ministry of Finance and Economy favors a policy of a weak Won in order to make exports more competitive, support corporate profits and stimulate jobs growth. On the other hand, the Bank of Korea and the Korean Development Institute, a very influential government think-tank, favor a strong currency to boost domestic consumption and reduce the price of imported raw materials and intermediate goods.

The Korean attitude to foreign investment has always been rather ambivalent, given a strongly nationalistic approach to development issues, and this continues, although since the crisis there has been strong government support of FDI. The aim for this year is to attract $10 billion from overseas, up on last year but well short of what was achieved immediately after the crisis. The head of the American Chamber of Commerce in Korea has suggested that the lack of coordination between government agencies and continued high levels of union militancy were the most important obstacles to foreign interest in Korea. Particularly worrying have been the strikes at the LG-Caltex refinery, and at the KorAm Bank, where workers were protesting against plans by Citibank to increase its stake in the company.

The reform of the large Korean conglomerates (Chaebol) is another issue on which there are wide differences of opinion. Some commentators, while recognizing that corporate governance practices need to be improved, argue that these companies remain the core of the Korean economy, and are especially important for continued export success. For those on the left, however, dismantling these companies has become a key goal. In fact the performance and structures of these large companies has improved significantly since the crisis, especially in the area of debt management, but there are still calls for much more drastic surgery by the government. In particular, the dominant position that Samsung now hold in the Korean economy has come under a lot of scrutiny, with demands that the group be broken up.

These are only some of the key issues facing policy makers in Seoul as they grapple with how to respond to the rise of China, and how to remain competitive in the era of the new economy. How the government acts over the next few months will be crucial to what is now one of Asia's most important economies and a key player in the global trading system.

John McKay is Director of the Australian APEC Study Centre.


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