The reform in post-crisis Korean was one of the most comprehensively and decisively implemented reform. Though impressed by the stunning around within a short period of time, many are now questioning about what has really changed in the economy. The concern comes together with the recognition of both benefits and the cost of the reform. While the reform has brought the Korean firm into a more stable and profitable state of the business, the economy is now suffering from weak investment, slow growth and rising unemployment. This study thus proposes to consider the Korean case as “visible success and invisible failure,” based on the following findings.
First, reform tend to achieve some nominal success in terms of making new laws and several quantifiable targets (eg. debt-equity ratio; introduction of outside directors in the board, selling of banks to foreigners,), and in the area where interests conflicts are less acute (opening capital and M&A markets to foreigners). In contrast, the reform tend not to make much success in really changing institutional conventions, habit and beliefs, such as enhancing transparency in the management or trust in labor relations.
Second, reform process involved tension between global standard and local specificity, which became the sources for the mixed results. Some elements of the global standards are not well fitted to the local specificity of Korea. Examples are discussed in the corporate governance and labor relations reform.
Third, interests politics in the implementation stage, plus the complexities caused by democratization and globalization, has caused weakening of state capability (or reform coalition) and implementation effectiveness and hence the distorted outcomes of the reform. While globalization necessitates increasing flexibility, the Korean management is now facing much stronger power of the labor after democratization. The outcome is not a fully flexible but segmented labor markets, divided between the core, unionized workers and unorganized periphery workers, and between the one over-protected and the other under-protected.
Fourth, it is important to have an effective system of legislative bargaining necessary for disputing parties to negotiate. Only with this institutional vehicle, interest politics can lead to some reform consensus. Korea tried to overhaul its financial system and conduct substantial financial liberalization in the early 1990s but it was partly aborted and partly distorted, which paved the way for financial crisis in 1997. The reasons were due to the lack of clear reform consensus, without which reform is more likely to be aborted or unsuccessful.
In the Korean case, real and strong consensus for reform arrived only after the 1997 crisis as the crisis persuaded the society of the need for reform. However, as he used to be a political outsider, the President Kim Daejung lacked brain pool and decided to make old guard (elite bureaucrats) his people by entrusting them with key posts for reform. The crisis brought back the state and its autonomy revived to the front as the banks, labor unions, Chaebols all staying in back yard.
Fifth, one source of the implementation difficulty in reform has to do with the institutional complementarities, and we need to take a proper sequence in reforms. One possible logical sequence seems to be moving from banking reform, corporate governance, labor relations, and then to finally business restructuring.
Now, an emerging question is whether our response (the reform blueprint) was right. The post-crisis Korea just tried to be more market or Anglo-Saxon model oriented but without paying attention to growth and competitiveness. While the firms have now lowered their debt ratios, they are not borrowing to make investment. The issue of wrong or right blueprint underscores the need to define the reform goal correctly. The goals of reform should not just be a movement toward market-oriented economy but toward a growth-oriented one/ or pro-growth market-oriented one.
Authors
Keun Lee, Economics Department, Seoul National University
Director, Center for Economic Catch-up of EAI
Byung-Kook Kim, Political Science department, Korea University
President, East Asia Institute
Chung H. Lee, Economics Department, University of Hawaii at Manoa
Jaeyeol Yee, Sociology Department, Seoul National University
This paper is done as a part of the GDN’ s global research project on “Understanding Reform.” Earlier version of this paper was presented at the 2003 GDN Meeting held in November 2003, in New Dehli, India. It has benefited from three rounds of detailed comments by two project coordinators, Jose Fanelli and Gary McMahon, and other seminar participants.
Once famous for its rapid economic growth named as East Asian miracle, Korea was subject to the shame of being one of the crisis-struck economies. However, the Korean economy also showed one of the most quick and strong turn-round since 1999. While some attribute to this recovery to the reform achievement, others still challenge this view and observe that not-much has been changed actually.
We consider Korea as a very unique country which has experienced, within a very short period of time, “everything” from miracle to crisis, and stunning turn-around. Especially, the Korean case raises two important issues. The first issue is how to link the old success regime to the recent crisis. In other words, the financial crisis of 1997 has again brought to surface the old debate on the role of market v. state in economic development. On one side is the market-based view that finds state intervention in financial markets (i.e., over-regulation by government and/or crony capitalism) as a culprit for the crisis (Summers 1998, World Bank 1998). On the other side is the statist view that blames the reckless deregulation of financial markets inspired by neo-liberalism for the crisis (Chang 1998, Crotty and Lee 2002, Singh 2002). Recently, the World Bank produced a volume entitled, Rethinking the East Asian Miracle (Stiglitz and Yusuf 2001).
While this first question has been digested by the literature, now an emerging issues is how to interpret the post-crisis reform and quick recovery. And we are already seeing some studies (Coe and Kim 2002, Hooley and Yoo 2002). But, these studies do not dig into the question of whether the Korean growth regime has really changed, whether institutional reform can be done so quickly and thoroughly, and whether recovery is really due to the reform.
Examining how Korea’s economic systems have been reformed offers an exemplary case study of the process and outcome of a reform intended to introduce global standards but conditioned by a country’s political economy and initial conditions. This study will examine the role that various interest groups (agents) played in the reform and how initial conditions constrained its process and the performance of the system that has emerged from that process. Specifically, the study will examine the role played by chaebols, bureaucrats, external pressure, and the prevailing ideas on reform and liberalization espoused in academia. Thereby, the analysis will reveal the motivating reasons for reform initiatives and will identify the factors responsible for the success and failure part of the reforms in Korea.
The reform history of Korea can be divided into the following three periods: (1) 1961-79 when General (then President) Park Chung Hee effectively ruled the country, starting the process of industrialization and rapid economic growth, (2) 1980-97 when the government undertook a number of reforms in an attempt to establish a liberal market economy, and (3) the years since the 1997-98 economic crisis when reforms were undertaken under the IMF auspices.
During the first period Korea pursued a state-led development strategy that put the government in the commanding position in resource allocation. It controlled credit allocation, thus directing resource allocation and disciplining large corporations to pursue developmental objectives. It also maintained a repressive policy toward labor, thus keeping the wage rate close to the shadow price of labor. The second period began in 1980 when General Chun Doo Hwan began his presidency (1980-87) upon the assassination of President Park in the preceding year. The new governments attempted some paradigmatic shift in political economy from state-led developmentalism to a more market oriented economy at the behest of liberal reform-minded economists. It did not, however, mean that reforms necessarily followed the prescriptions of the new paradigm: the course that the actual reforms took was full of detours as it was constrained by initial conditions, including institutional legacies, and buffeted by pressures from various interest groups. The economic crisis of 1997-98 is a consequence of reforms ill conceived and ill carried out in the preceding years and, consequently, understanding the reforms undertaken since the crisis requires our understanding the reforms undertaken during the 1980-97 period.
In the financial liberalization, we find that chaebol’s influence and bureaucrats’ strategic behavior affected and/or manipulated the blueprint of the reform as well as its implementations, as predicted by the thesis of economic entrenchment proposed in Morck, Wolfenzon, and Yeung (2004). In corporate restructuring, we find that initial conditions such as segmented labor markets, high premium for owner-controller of the firm, and so on, affected the course of corporate restructuring, and thus the standard Anglo-Saxon blue-print has not realized at its purist form, and/or has not worked as originally expected. This is consistent with the argument by Rodrick, Subramanian, and Trebbi (2004) that desirable institutional arrangements have a large element of context specificity arising from differences in historical trajectories.
As analyzed in Fanelli (2003), questions regarding the reform can be addressed in terms of the followings. First, why were some countries able to undertake reform while others were not? Second, what factors enabled some countries to successfully implement their reform program while the program failed in others? Third, why were some reforms more successful at delivering the expected outcomes than others?
In our attempt to answer these questions, we employ an “analytical narratives” approach that combines historical research with theoretical analysis (e.g., Bates et al. 1998, 2000). It is historical in that we describe and examine in temporal sequence the institutions and changes thereof in Korea since the early 1960s, and it is analytical in that we analyze the reform process with the explicit framework of reform dynamics and the associated causal hypotheses presented in section 2.
As the rest of the report will show, Korea has been relatively successful in carrying out policy and institutional reform. Whether this success has served the country well by putting the economy on a sustainable growth, is, however, yet to be seen, since new institutions, especially when they are alien institutions such as so-called global standards, do not necessarily work harmoniously with local-specific institutions. That is, successful institutional reform—successful not simply in changing institutions but in achieving its ultimate objectives—is not simply a matter of transplanting institution from another society: it must contribute to making the country achieve sustainable economic growth.
Next section discusses a theoretical framework for the analysis and derives the four main hypotheses. Section three is about the reform in the pre-crisis era. The pre-crisis era also play the role of the initial conditions for the post-crisis reform, because the post-crisis reform starts when the pre-crisis reform stopped. Section four gives a description of the post-crisis reform measures and their outcomes. The reform will be discussed in terms of the overall, political, and macroeconomic aspects, as well as financial, corporate and labor reforms. Section five is the main part that provides analytical narratives of the post-crisis reform as well as verification of the hypotheses with case studies. The last section provides a summary of the main finding of the study and a reflection on the current state of the Korean economy after 7 years of reform...(Continued)