Paper presented to the Annual Conference

of Studies in Political Economy held

in Ottawa, Canada on January 29, 1999
 
 

* We are grateful for comments by James Crotty, David Kotz, Robert Pollin and Gerald Epstein in Political Economy Workshop, Department of Economics, University of Massachusetts, Amherst on November 17, 1998, and by Gregory Albo, Robert Albritton, Jonathan Niyzan and Ronen Palan in Seminar, Department of Political Science, York University, Toronto on November 30, 1998, and by Ha-Joon Chang, Hong-Jae Park and Chul-Gyue Yoo in Seminar, University of Cambridge, on December 29, 1998.

1. Introduction

The economy of South Korea that had been praised as a miracle fell into an overall crisis at the end of 1997. The Korean government had to receive an emergency rescue loan from the IMF, and the latter has imposed many neo-liberal policies on the Korean economy. The Korean economic crisis has aroused hot debates on its causes as well as on the IMF’s reform programs.

In the debates we can discern two fighting views. One view argues that the peculiarities of Korean economic system, the so-called Asian model, were the key cause of the crisis (IMF, 1997; Krugman, 1998a, 1998b; Summers, 1998). On the contrary, the other view argues that the dismantling of those peculiarities due to the internal and external liberalization of the financial market brought about the crisis (Wade & Veneroso, 1998; Wade, 1998; Crotty, 1998; Crotty & Dymski, 1998; Chang, Park & Yoo, 1998). This difference on the cause of the crisis led to different suggestions on the reform or restructuring of Korean economic system. Although each argument contains some elements of truth, it fails to grasp the current crisis as a whole. In this paper, we discuss those two arguments, and suggest an alternative view on the causes of the crisis and on the directions of economic reform.

We interpret the current crisis as a combination of cyclical and structural elements. We are going to emphasize, firstly the inherently cyclical nature of the capitalist Korean economic growth, and secondly the role of the structural elements (e.g. the institutional changes prior to the crisis) in amplifying the cyclical upturn and aggravating the cyclical downturn and economic crisis. Generally speaking, the economic crisis includes a critical turning point as well as the crash. In the economic crisis the ‘industrial or commercial crisis’ precedes or follows the ‘financial crisis’ that includes credit crunch, bank panic and stock market crash. In the current Korean crisis the financial crisis was accompanied with the industrial crisis.

Many analysts claim that the current Korean crisis was basically foreign exchange crisis, arguing that it began autonomously from the foreign exchange sector, or that the foreign exchange crisis occurred under the ‘fundamentally sound’ macro-economy. Therefore, they stressed the contagious effect of the Thai baht crisis in May 1997 and the ruinous effect of the speedy massive outflow of speculative foreign capital. We don’t accept the claim that the foreign exchange crisis broke out of the blue. The claim might be a good excuse for those who had praised the miraculous growth of the Korean economy until just before the eruption of the foreign exchange crisis. But the claim didn’t pay attention to the enormous economic difficulties built up before the foreign exchange crisis. We point out that the Korean economy had been facing the cyclical downturn and crisis since early 1996, and that the cyclical downturn had been developing into the industrial crisis, the financial crisis and finally the foreign exchange crisis in November 1997.

On the other hand, the structural or institutional changes that the Korean government had been introducing since early 1990s (such as the financial liberalization including deregulation of the domestic financial institutions and opening of the capital accounts to foreign investors, and the loosening of industrial policies with regard to the coordination of private investments) had played only a secondly role in creating the industrial and financial crisis by stimulating or encouraging the over-investment and over-borrowing, as well as in triggering the foreign exchange crisis by allowing speedy outflow of foreign speculative funds invested in the stocks and bonds. .

Therefore, with regard to the directions and strategies of the industrial and financial reform, we suggest that the ownership and management of the firms should be reformed to take more accountability to the society. Korean-style monopoly capital, the chaebols (i.e. the large-scale, diversified, family-owned conglomerates), should be dissolved, and the individual big companies should be run by the shareholders, workers and other interest groups. And the financial institutions should be under the supervision of the ‘credit control committee’ which guarantees more stable and productive flow of credit as well as more equitable allocation of credit for the interests of all the people.

In Section II we appraise the two different views on the cause of the economic crisis in Korea, and in Section III we present our view on it. In Section IV we suggest our directions and strategies of the industrial and financial reform.

II. The Asian Model and the Economic Crisis

Most analysts agree that Korea had achieved very high rates of growth by means of the export-promotion under the government’s guidance. This so-called Asian model contains the following three interrelated peculiarities. Firstly, the industrial sector finances its investments mainly through the bank loans rather than through issuing bonds and shares. In other words, the Asian model is not the capital market-based system but the bank-based system. Secondly, the government intervenes in the selection of the strategic industrial sectors and provides ‘policy loans’ to the targeted sectors. Thirdly, therefore, there exists a close relationship of coordination and cooperation between government, banks and firms. Of course, the government occupies the most influential position.

After the occurrence of the Korean financial and foreign exchange crisis, many analysts have attributed its causes to the Asian model in one way and another. The anti-Asian model view (AA) lays its cause on the elements of ‘crony capitalism’ and ‘moral hazard’ contained in the Asian model, while the pro-Asian model view (PA) lays its cause on the collapse of the Asian model.

1. Anti-Asian model view (AA)


AA envisages two crisis-creating mechanisms. One mechanism is through moral hazard of both the industry and the bank. Believing that government will rescue them at hard times, the industry invests too much while the bank lends too much. Especially, Krugman(1998a, 1998b) emphasizes moral hazard as the cause of the Korean financial crisis. He argues that moral hazard produces the excessive risky lending and over-ambitious corporate expansion, and then concludes that "the specific sin that pushed Asia to the brink was the problem of moral hazard in lending"(1998b).

The other mechanism is based on the ‘crony capitalism’. Corrupt government officials put pressure on the banks to lend money to questionable investments, the collapse of which leads to industrial as well as financial crisis. IMF(1997) and Summers(1998) point out the close relationship between bank, firm and government as the systemic root of the crisis. IMF(1997) argues that "Korea’s current financial difficulties owe much to the system of directed lending and the close relationship that exists between corporations and the banking sector. The latter has resulted in ambitious investment decisions being subject to scrutiny only by bank managers whose appointment has traditionally been influenced by government".

These two mechanisms are neither theoretically nor empirically sound enough to explain the current Korean crisis. Firstly, since the tendencies of moral hazard and crony capitalism are inherent in the Asian model, AA must explain how moral hazard and crony capitalism had been ‘harmonious’ with high economic growth during the past 30 years (1960-90). AA can’t explain this thorny question. In Korea the moral hazard couldn’t be a big problem, because the government allocated credit according to its priorities, supervised its uses and refused to provide new credit to the inefficient firms (Lee, 1992; Chang, 1993). Of course, the government intervened to restructure the industrial sector whenever the industrial over-capacities and insolvencies became prominent. But the big firms whose investment projects failed were taken over or merged by other financially sound firms. In the cases where the government bailed out some important ailing firms by supplying the bank loans, it demanded the transfer of all the shares held by the real owners of the firms to their main trading banks.

On the other hand, the crony capitalism, i.e. the close relationship between government, banks and firms, had played the role of a quasi-internal organization, so that it had contributed to the achievement of the export targets and high economic growth more efficiently than the market mechanism (Lee, 1992). But crony capitalism could be blamed for the concentration of bank loans and economic power in a few business groups. After all, we can’t deny that government’s selection of the targeted sectors, its provision of policy loans, and its favoritism towards big firms had contributed to creating the so-called Korean economic miracle, although there was systematic harsh exploitation of the workers and peasants behind the miracle. Therefore, contrary to AA that moral hazard and crony capitalism are the root of the Korean crisis, one may easily accept PA that the close relationship between the government, banks and firms had contributed to a remarkable growth for more than 30 years.

Secondly, we should point out that the firms’ excessive investments and the banks’ excessive loans could happen during the boom without moral hazard and without crony capitalism. During the boom every capitalist is optimistic about the future, so that the industrialists competitively expand their operations and the bankers competitively increase their loans. Until the deluge the capitalists competitively swarm around the profitable areas of investments. It is a fundamental law of the capitalist economy. And in every capitalist country we can periodically observe this kind of overproduction of capital (i.e. excessive investments), the falling rate of profit, the bankruptcies of firms and banks, and the government rescue operations. Therefore, as Chang(1999) points out, those who see the Korean crisis as the implosion of moral hazard and crony capitalism should have been trying to find a scapegoat which would save the international lenders from the disgrace of admitting their own mistakes in lending money recklessly to overly stretched Korean banks and firms during the boom. In fact, the IMF rescue operations have provided an extraordinary moral hazard to the international financial operators, because they could make profits even when things went wrong (Palma, 1998).

Thirdly, contrary to AA, the peculiarities of the Asian model, i.e. the government’s allocation of credit, the bank-based system, and the government’s industrial policy, had broken down well before the crisis. Since the middle of 1980s the government had been trying to liberalize the financial system, due to the enormous growth of the private sector, particularly the chaebols, the increasing hegemony of the neo-liberalism, and the external pressures from the IMF, WTO and OECD. The government sold its held commercial banks’ shares to the public in 1981-83; it abolished most of the preferential policy loans ; it left interest rates determined freely in the money market; it licensed liberally the establishment of many private provincial banks and merchant banks; it opened the doors of stock and bond markets to foreign investors (Koo, 1993; Kim, 1997). In order to enter the OECD , the government had tried very hard to push the internal and external financial liberalization.

Furthermore, firms’ reliance on the banks had been decreasing. Big firms, particularly the 30 largest chaebols that were restricted by the ceilings of the total bank loans imposed by the government, resorted to the non-bank financial institutions (NBFI). In 1988 the top 30 chaebols owned 12 out of the total 25 security companies, 18 out of 35 insurance companies, and 13 out of 38 investment companies (later merchant banks) which have been blamed for the reckless borrowings of foreign short-term capitals. As in Table 1, the NBFI took larger shares of deposits and loans than the banks in 1992.

<Table 1> Share of Deposit and Loan Markets (%)
 

	1972 1982 1992 1996
Deposit  Banks NBFI Loans Banks NBFI	81.7 64.3 36.2 38.4 18.3 35.7 63.8 61.6 77.4 62.2 48.3 44.6 22.6 37.8 51.7 55.4

Source : Bank of Korea, Economic Statistics Yearbook, each year.

Also, in Table 2, we can see that the non-financial corporate sector had been diversifying its external financing.

<Table 2> Methods of External Financing by Non-Financial Corporate Sector

(%)
 

	1980 1988 1993 1996
Indirect Finance Borrowings from banks Borrowings from NBFI Direct Finance Treasury bills Commercial papers Corporate bonds Stocks Foreign borrowings Others* Total	36.0 27.4 32.8 31.3 20.8 19.4 13.7 15.7 15.2 8.0 19.1 15.6  22.9 59.5 53.3 47.0 0.9 5.3 7.1 1.3 5.0 6.1 14.7 17.5 6.1 7.5 15.0 16.9  10.9 40.6 16.5 11.3  16.6 6.4 -2.3 10.2 24.5 6.7 16.2 11.5  100.0 100.0 100.0 100.0

*Others include government loan and corporate credit.

Source : Bank of Korea, Analysis of Fund Flows, each year.

We can also see the demise of the Asian model in the government’s inability or unwillingness to coordinate the private investments. The government approved the establishment of the Hanbo Iron & Steel Company in 1993 when the Korean production facilities were excessively large. Later in January 1997 the Hanbo went bankrupt. And the government approved the establishment of the Samsung Motor Company in 1994 when the existing big three--the Hyundai, the Daewoo and the Kia-- opposed bitterly. In June 1997 the Kia became insolvent. Later, the Kia was sold to the Hyundai, and the Samsung to the Daewoo according to the government’ initiated restructuring plan.

In short, AA is not theoretically correct, because the economic crisis can occur without moral hazard or crony capitalism, and it is not empirically sound, because the Asian model had broken down well before the crisis.

2. Pro-Asian model view (PA)

According to PA, the Asian model weakened mainly due to the liberalization of financial sector that had been nearly completed in the middle of 1990s. Financial liberalization proceeded with deregulation of financial system and opening of capital market to foreign investors. Though PA is divided on what force, either domestic or external, compelled to liberalize the financial market, PA emphasizes that financial liberalization removed the ability of the government to control and coordinate the flow of credit (especially the inflow of foreign credit) and private investments. This led to the excessive or speculative investments and the excessive foreign debts.

Amsden & Euh(1997) argue that, "not until the early 1990s, when financial markets were deregulated, did the economy sink. Indeed, it was the government’s decision to allow banks and other financial institutions to borrow and lend without interference that created the current crisis." And Wade & Veneroso(1998) argue as follows: "Asian governments undertook radical deregulation, encouraged by the IMF, the OECD, and by the Western governments, banks and firms. They removed or loosened controls on companies’ foreign borrowings, abandoned coordination of borrowings and investments, and failed to strengthen bank supervision. By doing so, they violated one of the stability conditions of Asian high debt model, helping to set the crisis in train."

Therefore, according to PA, if the traditional mechanisms of industrial policy and financial regulation had been maintained, the Korean financial and foreign exchange crisis couldn’t have erupted. Chang, et. al.(1998), and Crotty & Dymski(1998) strongly hold this position. "In contrast to the near universal opinion expressed in the Western press, most Koreans correctly understand that their crisis was not caused by too much government regulation, but by too little. It was excessive liberalization, not the traditional East Asian model that failed" (Crotty & Dymski, 1998, p.44).

We agree that the financial liberalization has contributed to increasing the debt/equity ratios of the firms and the instability of the Korean financial market. As the government loosened the requirements of establishing new financial institutions, many merchant banks, insurance companies and security companies have been established, and the chaebols have financed their excessive investments through them in order to escape the government restriction on the bank loans to them. Also, we agree that the instant and massive outflow of short-term foreign capital that came in thanks to the liberalization of the capital transactions could cause foreign exchange crisis. However, PA tends to overestimate the effectiveness of the government interventions in regulating the cyclical development of the Korean capitalism and to underestimate the intrinsic flaws of the Asian model.

First of all, although the Asian model had contributed to the Korean economic miracle, it hadn’t always guaranteed the economic growth and stability. In particular, the success of the strategy of export-led growth depended primarily on the factors which were external to the government interventions, such as the demand in the world market, trade policies of the major importing countries, international competition. The economic cycles Korea has experienced since 1970 were deeply related with the export performances.

When the prospect of export expansion was good, the government extended huge domestic and foreign funds to the targeted sectors. If the export fell short of the expectation, the government had to deal with the bankruptcies and over-capacities in the targeted sectors

<Table 3> The Economic Cycles Since 1970
 

	trough peak trough
The 1st The 2nd The 3rd The 4th The 5th The 6th	Mar.1972 Feb.1974 Jun.1975 Jun.1975 Feb.1979 Sep.1980 Sep.1980 Feb.1984 Sep.1985 Sep.1985 Jan.1988 Jul.1989  Jul.1989 Jan.1991 Jan.1993 Jan.1993 Feb.1996 ?

Source : Ministry of Finance and Economy, Monthly Economic Review.

by liquidation and merger with injection of the public money. The government intervened to restructure the light industries during 1969-72, the heavy and chemical industries during 1979-81, and the industries of overseas construction and shipping during 1984-88. Since the eruption of the current crisis in November 1997, the government has been trying to restructure the industrial and financial sectors by injection of the public money.

We conclude that the government’s industrial policy and financial regulation can’t dispense with the inherently cyclical nature of the Korean capitalist economy which is heavily influenced by the external factors. Therefore, the PA’s claim that the dismantling of industrial policy and financial regulation generated the crisis is faulty.

Secondly, PA doesn’t understand that the domestic deregulation and external liberalization were inevitable historical agenda pushed by the internal and external forces. Internally, the chaebols, government officials and the general public were in favor of reducing the government interventions. The chaebols which had grown up by the government’s allocation of credit and entry barriers felt that they could earn more profit by borrowing domestic and foreign funds as much as they were pleased and by entering any promising industrial sector as they chose. The government officials under the influence of the prevailing neo-liberalism believed that the Korean economy grew too big to be managed by the government interventions. The general public was so much fed up with the government officials’ corruption and favoritism that they thought the market mechanism could achieve more fair and efficient allocation of resources.

Externally, the government of the USA, the most important export market, and the world economic organizations like IMF, WTO and OECD put pressure to the Korean government for liberalizing trade, foreign exchange and capital market. On the other hand, the Korean government and chaebols thought the liberalization inevitable, because the Korean economy, being the 13^th largest in the world, should participate in the globalization tendency. The government of President Kim Young Sam (February 1993- February 1998) who was the first civilian after 32 years’ long military Presidents adopted the slogan of ‘globalization’ as the most important policy objective; merged the Economic Planning Board with the Ministry of Finance (to become the Ministry of Finance and Economy); dismantled the industrial policy; participated in the WTO and OECD; and liberalized the financial market.

Thirdly, PA’s glorification of the Asian model is completely in contradiction to the general feelings of the Korean people, who think that the Asian model can’t be separated from dictatorship, favoritism and corruption. If anybody glorifies the Nazi regime due to its success in overcoming temporarily the German economic crisis, can you accept his or her view? To achieve the export expansion by raising international competitiveness the Korean government had prohibited Korean workers to organize labor unions, and had condemned them to longer hours with lower wages. The small and medium industries complained that the chaebols monopolized the bank loans, and that they exercised the monopolistic powers. It was an inevitable consequence of the government’s credit and industrial policy in which the government concentrated all the available resources in a few big firms at certain targeted areas.

After all, we assert that the main reason why the Asian model had been able to create the Korean economic miracle was, leaving aside the favorable external factors like the expanding world market, because the model had enormously facilitated the exploitation of the direct producers (i.e. workers and peasants) and the concentration of all the surplus-value in the hands of the large capitalists by expropriating the small and medium capitalists. In fact, the Asian model signified the coalescence between the government and monopoly capital. As we could clearly see in the government’s restructuring programs in 1969-70, 1972, 1979-81, and 1984-88, the government, in order to scrap the over-capacities and to avoid serious financial crises, arranged mergers and acquisitions by providing the chaebols with such financial incentives as special loans and suspension of bank-loan repayments. Most of the burdens have been shouldered by the banks, the government and ultimately by the people.

Fourthly, contrary to PA that the outflow of foreign capital caused the industrial and financial crisis, we argue that the former was only the result of the latter. Later, we will show that the massive outflow of foreign capital followed, not preceded, the domestic industrial or financial crisis.

III. The Origin of the Current Korean Economic Crisis

1) The cyclical nature of the current economic crisis

In the above, we assessed critically the two different views on the cause of the Korean economic crisis. Neither of them paid attention to the cyclical nature of the crisis which characterizes all capitalist economies.

We should emphasize the cyclical elements of the current Korean crisis, because it occurred during the downturn of the business cycle that had begun in the early 1996. Then, the investments were revealed too excessive, and the subsequent fall in the rate of returns made it difficult for the firms with higher debt/equity ratios to repay their debts. The defaults of the firms forced their related financial institutions to accumulate huge amounts of non-performing loans, which caused credit crunch and bank panic, leading to the refusal of the foreign lenders to roll over their loans, i.e. foreign exchange crisis.

In order to understand the Korean crisis more concretely, we should answer the following three questions. First, what transformed the boom into recession? Second, what caused investments and debts to be unusually enormous? Third, why didn’t the recession lead to the soft landing, but to such a severe foreign exchange crisis and the collapse of the whole economy? The first question is related to the cyclical element of the current crisis, while the second and third questions are related to its structural or institutional elements.

Let’s begin to answer the first question: what transformed the boom into recession? Marx(1967) and Minsky(1986) argued that the cyclical crisis is the inherent nature and the result of normal function of capitalist economy. Shown in Table 3, Korean economy faced the 6^th cyclical peak in February 1996. From 1996 the GDP growth rate and the growth rate of the fixed capital formation decreased substantially, and the deficit in the current account increased enormously (Table 4). Korean economy began to turn from boom into recession.

<Table 4> Main Economic Indicators
 

1992 1993 1994 1995 1996 1997

GDP growth rate(%) 5.1 5.8 8.6 8.9 7.1 5.5 Growth rate of fixed capital Formation(%) -0.8 5.2 11.8 11.7 7.1 -3.5 Current account($bil.) -3.9 1.0 -3.9 -8.5 -23.0 -8.6 External debts($bil.) 42.8 43.9 56.9 78.4 157.5 154.4

Source : Bank of Korea, Economic Statistics Yearbook, 1997.

This turn owed to the excessive investments. During the former half of 1990s the chaebols had undertaken huge investments in new capacity and new technology to compete with the domestic peers in the domestic market and the large Western multinational corporations in the international market. These investments had been undertaken under the optimistic expectation in the boom period, without considering the possible risky situation in the future.

In fact, the strategy of the export-led growth had been facing greater difficulties. In the field of low technology and low price items Korean firms couldn’t compete with Chinese and South-East Asian manufacturers, because Korean firms hadn’t been able to enjoy the benefit of lower wages since the people’s uprising in June 1987 and the subsequent wide spread formation of labor unions. In the field of high technology and high price items it wasn’t easy for Korean firms to compete with Japanese and other advanced countries’ firms. In particular, in the neo-liberal world market the international competition became severer and severer, and the size of the market tended to be smaller and smaller (Albo, 1996, 1997). Under these situations the Korean chaebols had tried to make breakthrough by investing heavily in the industries of electronics, semiconductor, car, shipbuilding, petrochemicals, and steel.

The chaebols had financed these investments by borrowing aggressively from the domestic financial institutions and the foreign banks. It made their debt/equity ratios very high. In fact, some bankrupt chaebols recorded the debt/equity ratios more than 1,000 % (see note 13), and had some borrowings locked at the investment projects with long gestation period. This kind of financing is just Minsky’s Ponzi finance. Thus, the Korean financial structure had turned from ‘robust’ to ‘fragile’ during the boom.

Then, how did this financial fragility transform itself into the financial crisis? It was not due to the rise of interest rate as Minsky(1986) argues, but due to the fall of profit rate as Marx(1967) argues. Excessive investments in the industries of key export items such as semi-conductor, iron & steel, petrochemicals were revealed due to the sluggish export expansion, leading to the low rates of capacity utilization, and then the falling rates of returns in the manufacturing industry. In 1996 its business and current rates of returns fell sharply from the levels of 1995, while the average interest rate for the whole borrowings remained nearly the same as in 1995 (Table 5).

<Table 5> Rate of Returns and Average Interest Rate (Manufacturing Industry)(%)
 

1992 1993 1994 1995 1996

Business rate* 6.64 7.04 7.65 8.33 6.54  Current rate** 1.53 1.70 2.74 3.59 0.98  Interest/borrowings*** 12.34 11.19 11.39 11.68 11.21

* Business rate is business profit (= total sales – manufacturing cost – cost of circulation)

divided by total sales.

**: Current rate is current profit (= the business profit – net financial costs) divided by total

sales.

*** It indicates the average rate of interest for the total borrowings.

Source : Bank of Korea, Analysis of Financial Statements, 1997

We, therefore, can infer that Korean financial crisis originated from the combination of the financial fragility and the fall of profit rate. As Clarke(1990-91) argued, those firms

that have higher debt/equity ratios can’t but fall into bankruptcies when they face the falling rate of profit, even though they have efficient technologies. In fact, from the beginning of 1997 several chaebols with high debt/equity ratios became insolvent in succession. In January the Hanbo Iron & Steel (no. 14 in the chaebols’ ranking) went bankrupt; in March the Sammi Special Steel (no. 28); in April the Jinro (no. 19); in May the Dainong (no. 33); in June the Hanshin Housing (no. 50); in July the Kia (no. 8); in October the Ssangbangeul (no. 26); in November the Haitai (no. 24) and the New Core (no. 25).

The serial bankruptcies of large chaebols inevitably undermined the soundness of banks and other financial institutions. Non-performing loans of commercial banks as of the end of 1997 stood at 22.6 trillion Won, 6.0 % of total loans. It almost doubled as compared with that at the end of 1996. At the same time, merchant banks recorded non-performing loans of 3.9 trillion Won at the end of 1997. As a result, the profit-loss accounts in 18 out of the total 26 commercial banks turned to loss in 1997 from the surplus in 1996, and merchant banks also suffered a large loss.

The insolvency of many firms and the huge accumulation of non-performing loans and the large losses of the financial institutions had brought out the credit crunch and the bank panic. These were the real contents of the Korean industrial and financial crisis.

2) The structural nature of the current economic crisis

In order to grasp the structural elements that had aggravated the cyclical downturn and crisis, we must answer the second and third questions. First of all, let’s deal with the second question: why were corporate investments so excessive, and why were corporate debt/equity ratios so high?

Firstly, due to the longstanding bank-client relationship, the banks had provided more money to the investment projects of the big customers. In particular, during the boom the banks felt the same euphoria as the big firms, so that even the banks tried to find out loopholes in the government-imposed credit ceilings on the chaebols.

Secondly, chaebols, which had grown rapidly thanks to the government’s preferential credit under the long traditional Asian model, have required much more autonomy for their investments and borrowings to compete their domestic peers and foreign large firms. In spite of their high debt/equity ratios thanks to the bank-based system, they needed much more funds, which could not be satisfied from the regulated domestic banks. Therefore, they demanded the government to deregulate the domestic financial market and to open

short-term inward capital flows. As a result, financial liberalization set out in the early 1980s almost completed in the middle of 1990s. Especially, 24 new merchant banks were established in 1994 and 1996, which were almost not regulated or controlled over their operations by government, and which were mostly owned by the chaebols. Thus, the chaebols could borrow large funds from them without being interfered. As a result, chaebols’ debt/equity ratios became higher and higher.

Thirdly, due to the liberalization of borrowing the short-term foreign capital, the Korean banks and firms could borrow large amounts of foreign debt. Of course, foreign lenders or investors were so happy with investing funds in the prosperous Korea that even the inexperienced merchant banks could borrow huge amount of foreign money for domestic as well as foreign investments. Thus, the total foreign debts increased very fast, from $ 43.9 billion in 1993 to $ 157.5 billion in 1996.

Fourthly, in the process of financial liberalization the power of the government to control and supervise the financial institutions has been lost. On the other hand, the commercial banks, which had been used to implement the government’s directives, didn’t have the abilities to evaluate the investment projects and to inspect their loans. Merchant banks were even worse than the commercial banks, because they had little or no experience in the standard commercial banking business.

Therefore, the structural elements that had contributed to making corporate investments more excessive than in the normal boom period and to making corporate debt/equity ratios much higher than in the normal boom period were the rising autonomy of the chaebols’ investment decisions, the internal and external financial liberalization, and the inability of the government to supervise and coordinate the corporate and financial sectors.

Finally, let’s answer the third question: why did the economic recession develop into foreign exchange crisis and a severe economic collapse? When the big industrial firms were falling into bankruptcies and the financial institutions were accumulating bad debts, it was natural that the foreign investors withdrew their money and abstained from rolling over their existing loans, and thus that the Korean debtors couldn’t repay their foreign debts on due dates. But this kind of foreign exchange crisis was aggravated by the higher proportion of the short-term debt which was 55 % of all foreign debts, and by the Government’s policy of maintaining the high won/dollar rate.

Since the government had made it easier to borrow the short-term rather than the long-term foreign capital, the domestic financial institutions borrowed the foreign funds in short-term and lent them to the domestic and foreign firms in long-term. This mismatch of maturity aggravated the difficulty of repayment by the domestic financial institutions, because the latter couldn’t collect their loans due to the domestic financial crisis and the foreign exchange crises abroad.

On the other hand, the Bank of Korea had tried to maintain the Korean won/dollar exchange rates by injecting huge amounts of dollars into the foreign exchange market. In July 1997 the won/dollar spot rate was 892.00 in the domestic market, but in the offshore futures market the rates were 1,200-1,300. Foreign exchange speculators were selling the won-denominated securities to buy the dollars. During the whole year of 1997 the Bank of Korea injected 26 billion dollars into the foreign exchange market, out of which 11.8 billion dollars were released during October and November 1997. In fact, the Bank of Korea used most of its foreign exchange holdings to maintain the won value in the face of the massive assault on the won.

As the foreign exchange holdings ran out, and the industrial firms and financial institutions faced bankruptcies, foreign banks refused to roll over their loans. Faced with the prospect that the Korean firms and banks could not repay their foreign debts on due dates on a large scale, the government applied for the IMF special rescue loan on November 21^st 1997, and it was granted on December 3^rd when the Presidential election campaign was reaching the peak, the election day being December 18^th.

We can conclude that the current Korean industrial and financial crisis originated from the cyclical nature of capitalist economy itself. In the 1993-5 boom, the industrial capital represented by the chaebols had undertaken excessive investments under the internal and external pressures of competition and the optimistic expectations, which substantially increased the debt/equity ratios. On the other hand, there were the structural elements that amplified and worsened the excessiveness of investments and debts. Based on the longstanding close relationship between the banks and the big firms, the banks have recklessly responded to the loan demands of the big firms. In addition, the internal and external liberalization of the financial market supplied substantial domestic and foreign loans to the big firms. Furthermore, the government and the Central Bank were unable to supervise the activities of the financial institutions and to coordinate the industrial investment decisions. After all, those firms carrying higher debt/equity ratios couldn’t but fall into bankruptcies when they faced the falling rate of profit. The consequent industrial and financial crisis developed into foreign exchange crisis due to the refusal of foreign investors to roll over their loans.

IV. A New Perspective for Economic Reform in Korea

1. The economic reform programs of the IMF and PA’s opposition

Here we will confine our discussion to the long-run structural reform programs of the IMF, i.e. financial reform and chaebol reform. Firstly, the Stand-By Arrangement between the IMF and the Korean government in December 1997 required Korean government to reform the financial sector in the following ways. 1) To restructure and recapitalize the financial sector, and make it more transparent, market oriented, and better supervised. 2) To deregulate capital market essentially in order to ensure an efficient allocation of resource, and remove the restriction on mergers and acquisitions in order to raise the attractiveness of the equity market. 3) To liberalize capital account in order to allow or encourage the corporate sector to borrow directly on international capital markets, and allow foreigners to invest domestic money market instruments and the corporate bond markets. 4) To pass early legislation that will make the Bank of Korea (Korea’s central bank) independent and with price stability as its overriding mandate.

Secondly, the IMF required the Korean government to reform the corporate governance and corporate structure in the following ways. 1) To raise the transparency of the corporate management, the listed companies will be required to subscribe to full disclosure, independent external audits and provision of consolidated statements. 2) To reduce the inflated debt financing, the system of mutual loan guarantees among affiliates will be made more transparent by introducing consolidated balance sheets. 3) To restore market discipline and remove pervasive moral hazard problem, the bankruptcy provision under Korean law will be allowed to operate without government interference. The government will break from its past policies of providing support and tax privileges to bail out individual companies and from forcing mergers between sound and unsound companies.

With regard to these kinds of reform programs, Summers and Krugman completely agree with the IMF and argue that these structural reforms will make the allocation of capital more efficient and will increase the confidence in Korean economy. Summers(1998) says: "What we know for sure is that they would not be economically sustainable, in the long run, without these kinds of reforms. … Decisively implemented, these changes will help address Asia’s shorter- and longer-term imperatives: they will increase confidence and attract private capital in the short run. And they address the longer term problem of allocating capital on a more market-oriented basis." Also Krugman(1998b) says: "Many people have argued that IMF’s current insistence on major structural reforms is mistake, that it involves going beyond the Fund’s mandate. The answer, I think, is that given what U.S. Treasury officials refer to privately as the "rathole" problem, --- that is, the risk that money will simply disappear into corrupt, politically connected institutions, and that Senator D’Amato will notice--- the Fund must either confront crony capitalism or stay out of the picture altogether."

On the contrary to AA, PA strongly criticizes the reform programs of the IMF. In particular, Crotty(1998) argues that, " If the IMF agreements are fully and permanently implemented, …it would then be almost impossible to reconstruct an economic system that reflects Korean values and works in the interests of labor and the majority of people. All of the structures, instruments and policies that were used to create the Korean economic miracle would have been eliminated." Also Wade & Veneroso(1998) say: "If the IMF prescriptions for reshaping Asian financial systems into something more like the Western model require, as a condition of viability, a running down of corporate debt, and if the inflation route is ruled out, then the social costs are likely to be huge and long-lasting."

In the followings we will suggest alternative directions of economic reform which will contribute to the economic stability and growth, and to the democratic control of the financial and industrial corporations.

2) An alternative direction in Korean financial reform

We do neither accept the financial reform programs of the IMF nor the present Korean financial system. The Anglo-American style of the capital market-based system will subject the corporate activities to the speculation of the stock market, so that it will not uphold the long-term economic growth, economic stability and equality. And under the capital market-based system with the complete external opening of capital accounts the multinational capital will easily dominate the Korean economy. On the other hand, the present Korean financial system also exposed itself to many problems we have already pointed out. Therefore, we must devise a financial system that can break up the longstanding favoritism towards the monopoly capital, and that can enhance the merits of the bank-based system.

i) In order to emphasize the public nature of the financial institutions, their ownership should be dispersed to a large number of shareholders. At present, the government is attempting to permit big shareholders to dominate the banks by amending the Bank Act’s limitation on individual share holdings. The existing Act doesn’t permit any individual to hold over 4% of the equity capital in the general commercial banks and over 15% in the local commercial banks. If the limitation on shareholding is removed, the chaebols will dominate the banks by holding the largest shares and will use the banks as their own treasury departments. Then, all the Korean people should live under the chaebols’ dictatorship, while the cyclical ups and downs will be much more amplified.

ii) In order to prevent the excess and shortage of loans according the cyclical phases, the loans by the financial institutions should be determined for the interests of the society as a whole. For this, each financial institution should form its own ‘credit control committee’ that is composed of all the stakeholders such as the shareholders, the borrowers, the depositors, the employees and the citizens. This committee will decide the eligibility of loans by giving ex ante approval on the big loans and ex post consent on the small loans. And this committee’s decisions should be supervised by the higher level credit control committee.

The credit control committee that will serve as an organ of the national consensus suggested by Cox (1986) will help to allocate the credit according to the requirements of the society as a whole instead of the private interests of the financial institutions, and to achieve a balanced distribution of the credit among the various social objectives, and to stabilize the economy by preventing the credit from being oversupplied in boom or being undersupplied in slump. Thus, the credit control committee composed of various interest groups will contribute to the solution of the problems contained in the bank-based system.

iii) The role of the Central Bank (Bank of Korea) and the composition of Monetary Policy Committee (MPC) must be altered. The Bank of Korea (BOK) should provide the credit control guidelines to the credit control committees of the financial institutions in harmony with the government’s economic policies. But the Bank of Korea Act revised at the end of 1997 under the influence of the IMF puts its primary objective on the maintenance of the currency value, that is, the price stability, and separates BOK from the Government completely. The credit control role of BOK, which was one of the two most important objectives inscribed in the previous Bank of Korea Act, was abandoned in the new Act, so that BOK may adopt more and more restrictive monetary policies. And the complete independence of BOK from the government, as Epstein (1993) argued, may urge BOK to take policies favoring the capitalists as a whole rather than the workers and the ordinary citizens in Korea where the tie between banks and firms is closer and the labor unions are weak.

Thus, the Bank of Korea should share the power of the credit control with the government, and its Monetary Policy Committee should be composed of the deputies from the various interest groups. As Pollin(1993) suggests that the Board of Directors of the regional Federal Reserve Banks be chosen by the direct election, we can consider the direct election of the members of the Monetary Policy Committee of the central bank.

iv) Although the IMF demanded the government to deregulate capital market and to remove the restriction on mergers and acquisitions, it is necessary to control speculation in capital market, so that the activities of firm should not be subject to the volatility of capital market. As Keynes(1936) argued, "when the capital development of a country becomes a byproduct of the activities of a casino, the job is likely to be ill-done"(p. 159). Therefore, the speculative transactions in the circulation market of the securities must be regulated. For instances, as Keynes(1936) and Pollin(1995, 1997) suggested, we may impose capital gains tax or turnover tax on the dealings of securities in the circulation market. And to encourage the long-term horizon in the firm’s management, the antagonistic mergers and acquisitions in capital market should be regulated.

v) According to the conditionality of the IMF emergency rescue loan, the Korean government has completely liberalized the capital market to foreign investors. However, since the liberalization of capital accounts disturbs the domestic financial market through massive and sudden inflow and outflow of the speculative funds, and restricts the effectiveness of the domestic policies toward stability, equality and growth, the control on inflow and outflow of foreign exchanges should be reinstated.

1. An alternative direction of the chaebol reform

On the other hand, PA argues that the chaebol system was one important element in creating the Korean economic miracle, and therefore that it should be maintained. As the chaebol has diversified in the various fields of business (e.g. many industrial sectors, insurance companies, securities companies, department stores), it can benefit from the diversification of risk, and it can mobilize huge money for entering into new industrial sectors and for improving international competitiveness (Chang, et.al., 1998).

We think that the chaebol reform programs of the IMF and Korean government and PA’s pro-chaebol arguments are missing the following salient problematic aspects of the chaebol system. Firstly, the chaebol is managed and controlled by the familial boss one man, and the power of management and control is inherited to his heir. It is based on the fact that the family holds on average 8.5 % of a chaebol’s total equity and that its member companies hold 34.5 % through the reciprocal share holdings. The chaebol is the boss’ kingdom where he decides what to do the treasures of the kingdom. We all know that the bosses spent huge money on bribing leading politicians and higher bureaucrats, including Presidents , and that the chaebol Hyundai’s boss, Mr. Joo Young Chung, used company money and company staff for his Presidential election campaign in 1992. We believe that if all the surplus-value exploited from the workers had been productively invested, Korean economy should have recorded much higher growth rates.

Secondly, the chaebol has been exercising the monopolistic practices. It does tacit collusion with other chaebols in pricing its products and in bidding for government’s constructions; it monopolizes the loans by the banks; it dominates and expropriates its related or subcontracted small and medium industries; it retards the growth of independent and ingenious new enterprises by buying them up.

Thirdly, the chaebol’s economic power is accompanied with its social and political power. The chaebols have newspapers, TV stations, universities, research institutes, hospitals, golf courses and professional sports teams. The chaebols donate generously to their favorite political party and politicians. Their organ, the Federation of Korean Industries, produces many recommendations for their interests in various fields.

We suggest an additional chaebol reform with regard to its ownership and control structure.

1. To make corporate decision-makings democratic, and to raise corporate accountability to the society, the composition of the board of directors should be altered. Not only the representatives of shareholders but also the representatives of employees, credit-supplying financial institutions and general citizens should become the directors.

In the end, the chaebol system should be dissolved. The diversified conglomerate should be divided into many independent corporations; the familial boss should not be able to exercise despotic power; the managerial prerogatives should not be inherited to the familial heir; the monopolistic power of the chaebol over economic, social and political spheres should be eliminated.

V. Conclusion

The current Korean economic crisis was neither caused by such peculiarities of the Korean economic system as crony capitalism and moral hazard, nor by the breakdown of the Asian model due to the financial liberalization. The current crisis should be understood as a normal cyclical crisis inherent in any capitalist economy. Periodically, excessive investments, excessive borrowings and lendings, falling rate of profit, financial fragility, industrial and commercial crisis, credit crunch, and bank panic occur. For understanding the specific structural elements that aggravated the cyclical crisis, we introduced the higher debt/equity ratios of the corporations based on the traditional Asian model, the internal and external financial liberalization, and the weakening government’s control on the flows of domestic and foreign credit.

Based on our perception of the current crisis, we neither agree to the economic reform programs of the IMF nor to the present system favored by the pro-Asian modelists. We suggest the following directions and strategies of financial reform. We should strengthen the public nature of the financial institutions by dispersing their shareholdings widely among the people. In order to regulate the credit flows anti-cyclically, to channel the funds to productive investments and to enhance the social egalitarianism, the new ‘credit control committee’ composed of the various interest groups should be created at each financial institution and the Central Bank. To restrict the speculative dealings of the securities in the capital market, capital gains tax and transaction tax should be imposed on them. To escape the damages inflicted by the massive outflow of the foreign capital, various measures of foreign capital control should be reinstated.

With regard to the chaebol reform, we suggest that the new board of directors should be composed of not only shareholders but also employees, financial institutions and general citizens, and that the shares should be dispersed to employees in lieu of bonus and financial institutions by debts-shares swap.