The mexicanization of Korea

By Mike P. McKeever, 9 January 1998

Here are some thoughts on the Korean situation plus a reference to some detailed background of the IMF agreement. I wrote this before I heard about the Wall Street Journal’s piece agreeing with the World Bank’s view suggesting a similar line of reasoning, so the conclusions may be less important then the web address of the IMF agreement’s details. This is an important discussion, so I think it’s worth a little more light.

Recently the IMF agreed to support Korea with a bailout of more than 50 billion dollars. In exchange, the Korean government agreed to a number of actions. This piece looks at some of these actions critically.

To read the complete list of actions required by the IMF, access this web page: http://kiep.go.kr/; then click on English; then click on IMF Program Update; then click on IV. Official Announcements and Speeches; then click on Special Announcement by Deputy Prime Minister Lim, Chang-Yuel, 12-24-97. The exact web address is http://kiep.go.kr/IMF/hot-4-2.html.

Here’s my admittedly simplistic take on the crisis: The government encouraged the chaebols to expand and become aggressive exporters in the world markets; to do so, the companies were more optimistic than the markets warranted and borrowed heavily, internally and externally, to finance projects; many of the projects were poor investments; since the government encouraged the expansions in the first place, it more or less guaranteed the loans (I’m not sure if that was in writing), so neither the banks nor the managers paid much attention to the economics of the deals; now, the loans are going bad and the government can’t make good on its promises because the currency value has fallen; also, the government is leaving the banks and companies to take the fall; I don’t know about deposit insurance, I presume that they don’t have any, so the big losers may be depositors.

A sensible economic policy in this case would be to allow the currency to float; to limit imports to a value supported by exports (to be implemented by strict foreign currency controls as well as controls on imports); to stimulate domestic demand by keeping interest rates low so that surviving companies can stay open; to negotiate roll-overs on as many loans as possible and allow the rest to go into foreclosure, except for a few large employers (where the government can either explicitly guarantee the loans or negotiate with foreign buyers who will agree to keep jobs open); and, to try and keep employment as high as possible during a transition by keeping as many companies open as possible via government loans or whatever. With regard to this last point, I am referring to a transition period where policy slows the job losses to the economy as much as possible.

Regardless of whether everyone agrees with each particular item above, the following list of IMF REQUIREMENTS will be very interesting.

1. The IMF requires that interest rates be raised to at least 30%. The probable reason for this is the hope of attracting international hot money into high yielding bonds. Sound familiar? The short term effect is a slight currency stabilization and an increase in domestic demand, including a demand for imports. The long run effects are catastrophic: increasing business bankruptcies (since no normal business can exist at 30% interest rates); job loss; increasing poverty and social unrest. All this becomes amplified when the government attempts to lower interest rates and reflate the economy—then the hot money leaves in an instant.

2. The IMF requires significant reductions in import barriers. I have no idea why the IMF requires this at a time when the economy is in serious trouble. This is a bonehead move, or worse, a sell out to multi-nationals.

3. The IMF requires the elimination of restrictions on capital movements into the country. Now, foreign investors are legally able to buy Korean companies on the cheap, whereas before foreigners were restricted in their investments into the country. I suppose the IMF doesn’t think that Koreans can run a business—much better to let kindly and efficient global companies take over.

4. Some of the IMF requirements are almost neutral, such as strengthening deposit insurance, requiring better standards of financial reporting and so forth.

I think it’s kind of scary; maybe there needs to be some new management at the IMF. What do you think?