A Bailout Won't Do The Trick In KoreaRudi Dornbusch
Korea is the most recent emerging market domino to tumble. No surprise that the country is asking the IMF for a giant $60 billion package to avoid defaulting on its external debt. It is yet another economy that had prudent public finance and a small public debt, high growth and a good name. But under the surface there was a different reality: two decades of failure to promote regulation, competition, strict credit policies, and clean government. Korea desperately tried to become like Japan and the bad news is, it succeeded. What went wrong and what to do about it?
Excessive liquidity in the world capital market encouraged indiscriminate lending in Asia. Just about any country, bank, or company could get loans at a slight premium over what the U.S. government pays. Reality was set aside, and testing the credit-worthiness of loan customers was abandoned. No one added up total loan exposures or the timing of cash flows to pay for loans falling due. There is an irony in all this. In the 1980s, we suffered an emerging-market debt crash in the context of a tightening of world liquidity. This time around, the problem is too much liquidity.
There are several fundamental problems of the Korean economy that lie behind the current banking and corporate crisis. Statism has become counterproductive. Even today, the government is central to the course of the economy in a way that is only matched by Japan. Statism was helpful decades ago at the threshold of development. But now, planning and interventionism must give way to markets and decentralization in order to solve the increasing complexity of economic decisionmaking.
CLUELESS. The financial system has become dysfunctional. For decades, Seoul allocated credit, and the financial system was merely the cash register. Today, that system is plain bankrupt, with a cleanup cost estimated at 15% of gross domestic product.
The industrial structure of Korea is unbalanced. A handful of companies control 50% of GDP. These chaebol--large in terms of concentration and vast in the range of activities--operate under a centralized, bureaucratic leadership. They lack the agility to adapt to rapidly changing opportunities and needs. In fact, they have no clue as to their future.
Korea is caught between competition from low-wage economies such as China and Southeast Asia on one side, and Japan on the other. Korean manufacturing will find it increasingly difficult to compete in the world market. The competitive devaluations of Asian currencies is a further burden.
Korean democratization has changed the workplace. It has brought to an end a world where wages lagged productivity by years, where labor was patient beyond belief, and strikes only took place after work. Democratization has also brought to the surface vast political corruption, as pervasive as the bad debts in the banking system. In fact, they are twins.
Just as in Japan (or in Germany), everything in Korea functions with clockwork precision. The trouble with so much regimentation by government and corporate bureaucracies is that creativity is stifled. Despite impressive human capital, innovation hasn't caught on. Getting ahead is just not an engineering question.
ELBOW GREASE. Korea cannot get out of the crisis with quick fixes. Some extra devaluation, a little reform, more subsidies to bad businesses and banks, and an external aid package that shores up loans won't do. As this disgraced government is about to lose at the polls, the new leadership must make a dramatic break. Korea needs to open up its economy fully to outside participation. Foreign investors must take over and clean up the mess with a wave of uncompromising corporate and banking restructurings that are long overdue. Neither the government nor the Korean business community can do the job.
The almost daily call on the International Monetary Fund for new emergency loans is rapidly subverting that agency and the functioning of international capital markets. The IMF has become a lender of daily resort. A crisis such as the present one must be exploited to put in place a better-functioning economy. A minor attempt was made in Indonesia. In Korea there is a chance to go a great deal further. Foreign lenders, the IMF, the U.S., and whoever else participates must settle for nothing less. Insisting only on a budget package that sets aside some money for bank cleanup won't cut it. But if Korea is unwilling, a moratorium on commercial debt service will teach both the country and its markets an overdue lesson.