Korea's Comeback

The Thirst for Funds Drives

March 2, 2000

Report

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South Korea

Emerging Markets

Economic Crises

North Korea

Overview

One year ago, Korea was in trouble. Its banking system, inadequately supervised, collapsed. Industry, lacking financial discipline, expanded unproductively with its "too big to fail" private firms crowding out smaller rivals. Labor market rigidity weakened the competitive position of Korean industry. The financial crisis that resulted gave rise to hopes that significant reform would address all three dimensions of Korea's vulnerability. The crisis provided a window of opportunity to seek a coordinated solution, given that the overall condition of the economy was everyone's concern. However, Korea's quick recovery may have eliminated that opportunity as each interest group focused on its own well-being, resulting in social and political fragmentation. The regional focus of the 2000 parliamentary elections reflected this fragmentation. No consensus emerged on a reform agenda needed to dramatically restructure the economy. With the government lacking support to continue comprehensive reform, new vulnerabilities began to appear.

Before the crisis, the government implicitly insured depositors' bank loans to the large conglomerates. These guarantees left the banks with little incentive to develop credit analysis and loan monitoring skills necessary for prudent lending. Now, the government's increased ownership of the nation's capital assets may further weaken market discipline. Again, the insured agents, both firms and bankers, will not take proper care to manage risks. Despite the stalled political reform process, market forces may yet change Korea precisely because the banks are unlikely to resume the central role they once played as the principal source of investment capital. Companies will have to turn to capital market alternatives -- bond, equity markets, and Internet banking -- for sources of new funding. As they seek new forms of financing, firms will be compelled to change management practices, concentrate on shareholder value, and adopt disclosure standards that are more rigorous than what is demanded by Korean law. The collapse of the banks will have another beneficial effect: weakening the cozy links between firms and politicians who once provided privileged access to cheap credit in exchange for contributions

More on:

South Korea

Emerging Markets

Economic Crises

North Korea

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