Reviewing President Kim's First Two Years
Building A New Economy
By Peter M. Beck
Korea Economic Institute of America
February 24, 2000
Korea Times

When Kim Dae-jung narrowly won the presidential election in December 1997, he inherited an economy in tatters. Battered by the economic upheavals that swept across Asia in the summer and fall of 1997, Korea teetered on the edge of default and her proud economic Mandarins were forced to go to the IMF with cup in hand. The ``Miracle on the Han River'' seemed to evaporate overnight. The loan package arranged by the IMF in late November initially failed to stop the economic hemorrhaging, and then-presidential candidate Kim Dae-jung briefly questioned the conditions attached to the IMF loans. However, upon his election, Kim quickly recognized the importance of the IMF agreement in restoring Korea's economic health. Koreans received a hint of the type of leader they had elected when Kim effectively took the reins of government two months before his inauguration.

The situation was too grave to wait on. Korea was experiencing its most severe economic contraction in more than four decades. Given the severity of the downturn, Korea's economic recovery over the past year has been nothing short of spectacular, and the Kim administration rightfully deserves much of the credit. Despite a press that constantly referred to the ``IMF hanpa'' (cold wave) and ``IMF cheje'' (regime), President Kim helped remind Koreans that the economic crisis was home grown Indiscriminate lending by Korea's banks to the chaebol (conglomerates) led to reckless investment decisions and a string of bankruptcies in 1997. When the economic crisis hit Southeast Asia, foreign banks and investors began to see Korea's vulnerabilities in a new light, which eventually led to panic.

Thus, the first task of the Kim administration was restoring investor confidence. The administration held a series of intensive meetings with foreign creditors and quickly succeeded in rescheduling one-quarter of Korea's short-term liabilities. The successful launch of a sovereign bond issue in New York two months later confirmed that the stabilization package was taking hold.

The Kim administration also recognized that the key to restoring Korea's economic vitality was addressing the vulnerabilities that led to the crisis in the first place. The government launched a series of sweeping reforms of the financial and corporate sectors and adopted a proactive foreign investment policy. Scores of banks were closed, merged or taken over by the government, and 64 billion won was earmarked for recapitalization of the surviving banks. The chaebol were pressured to lower their perilously high debt-equity ratios and establish greater corporate transparency and accountability. In undertaking reform, the government has faced a dilemma. On the one hand, the government has declared the invisible hand of the market rather than the visible hand of the government to be the guiding principle for the Korean economy.

On the other, the government's sometimes heavy-handed approach to financial and corporate reform suggests that it has merely gone from picking the winners to picking the losers. Foreign direct investment, instead of being seen as a threat to Korea's sovereignty, is now viewed as vital to the financial and corporate reform process. Foreign investment can help firms lower not only their debt-to-equity ratios and secure a more stable and long-term form of investment, but they can also acquire new technologies and managerial practices. Phillips Electronics, Goldman Sachs, Hewlett Packard and Qualcomm are just a few of the companies that have made significant investments in Korea -- a clear vote in favor of Korea's long term economic prospects.

Foreign analysts generally agree that Korea's turnaround has been truly impressive. The numbers speak for themselves After shrinking by 5.8 percent in 1998, the economy roared back in 1999, posting a better than 10 percent growth rate. What began as a technical rebound and fiscal stimulus-led growth gradually evolved into a robust recovery. Exports also recovered, with semiconductors, automobiles, liquid crystal displays and mobile phones leading the way. Foreign investment during 1998 and 1999 exceeded that of the cumulative total for the previous 40 years. Foreign exchange reserves went from a perilously low $3.9 billion in December, 1997 to $74.0 billion at the end of 1999, nearly double Korea's short-term external liabilities. The exchange rate has strengthened to the point of actually causing concern about eroding Korea's international competitiveness (which has already been in decline since the early 1990s), and unemployment has come down from the highs of a year ago, though it has risen again recently. Despite worries of a second economic crisis in the wake of Daewoo's implosion in July 1999, the economic recovery remained on track.

In spite of the sharp downturn, labor unrest has failed to materialize for the most part, defying the expectations of most foreign analysts. This reflects the fact Kim Dae-jung came into office with labor's support and trust. While the disparity between rich and poor has widened (although still much better than that of the United States), the Kim administration has aggressively expanded the social safety net without exploding the government's budget deficit.

The chaebol have rightly received the brunt of the blame for leaving the Korean economy vulnerable to crisis, but it does not logically follow that they should be broken up. Rather, the chaebol must focus on their core competencies. For example, the economic rationale for building the Samsung automobile plant in Pusan was highly dubious, but Samsung Electronics will continue to be one of the engines of growth for the Korean economy and a world leader for key high-tech goods. Samsung and others gambled correctly that CDMA (code division multiple access) would become the global standard for wireless telecommunications. The ``big deals'' pushed by the government are at best an intermediate step in the corporate restructuring process. Besides leading to increased market concentration, the business swaps undertaken to date have not led to significant capacity or debt reduction.

Daewoo's implosion sends a clear signal that no company is ``too big to fail.'' Former Daewoo chairman Kim Woo-choong displayed the ultimate hubris Rather than trim down his far-flung corporate empire, Kim instead undertook an expansionary business plan and raised Daewoo's indebtedness to an unsustainable level. Foreign analysts are carefully watching to see how the company is liquidated and the role foreign companies play in the process. Several international auto makers are currently vying for Daewoo Motors. The temptation may be great to try and keep Daewoo Motors in domestic hands, but Hyundai already controls 70 percent of the domestic market and the auto industry would benefit greatly from a capital, technology and management infusion if Daewoo were sold to a foreign auto maker.

A number of the smaller chaebol (6-64) have entered into workouts with their creditors, but little actual progress has been made to date. Most chaebol have lowered their debt-to-equity ratios, but there is still a long way to go. The bulk of the declines to date have been a result of questionable asset revaluations and equity issues rather than the actual reduction of debt burdens. One real sign of progress will be when the chaebol release consolidated financial statements, giving investors and creditors a clearer picture of a conglomerate's overall financial condition. Ultimately, the chaebol must adopt professional management, but, as the Daewoo case shows, few founding families are prepared to depart willingly.

Small and medium-sized firms are also vital to Korea's economic future. Companies like Daum Communications and Serome Technology are mastering the global information technology market. Investors are increasingly recognizing this transformation as reflected by the shift in stock ownership from the blue chip KOSPI companies to the hi-tech startup-heavy KOSDAQ.

While most observers admire Korea's rapid recovery and the determination of President Kim to build a new economy, many remain skeptical about the chaebols' commitment to restructuring. Much remains to be done in the financial sector as well. Banks will require a second major capital infusion. Many remain saddled with nonperforming loans and have yet to mark to market. With the nationalization of several banks, the government must now devise an effective exit strategy. Korea First Bank was finally sold to Newbridge Capital after a year of negotiations, but the deal between Seoul Bank and HSBC fell through. Ironically, of the two deals, the proposed HSBC-Seoul Bank merger was widely viewed as being more beneficial to the Korean banking sector as HSBC was considered a long-term market player and Newbridge a quick return-oriented institution.

Non-bank financial institutions (NBFIs), like the investment trust companies, will also require government attention sooner rather than later, but likely not until after the April 13 elections. Ultimately, NBFIs should be subject to government supervision. More broadly, banks and NBFIs alike must improve their credit analysis and lending practices.

This process has only just begun and will take considerable time. Finally, Korea's external environment remains uncertain. A sharp downturn in the economies of one or more of Korea's leading trade partners could dampen Korea's recovery. Japan's economy remains anemic and shows signs of reentering recession; China faces the difficult task of industrial restructuring; and the record economic expansion in the United States cannot last forever. Moreover, world oil prices have tripled in the past year.

President Kim correctly saw the economic crisis as an opportunity to lay the foundations for a new economy, one that is a dynamic mix of large and smaller firms, and information technology-based. The Kim administration has advanced the reform process further than any previous government, authoritarian or democratic, but much remains to be done. One of the true measures of success will be when Korea is able to improve its international competitiveness. Nevertheless, I am reminded of the old Korean proverb, ``Shijaki banida'' -- beginning is half the job.

* * *
Peter M. Beck is the Director of Research and Academic Affairs
at the Korea Economic Institute of America in Washington, D.C.
He can be reached by e-mail at pmb@keia.org

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