Korean crisis? We've been here before
Sunday 14 December 1997
So often it is the non-specialist who can score the bull's-eye. For this surely captures the two most important issues that South Korea's difficulties raise for the rest of the world. The first is the extent to which longer- established developed nations face a real long-term threat from the relatively newly industrialised ones: whether the economic, cultural and political values of East Asia inevitably result in superior economic performance. The second is whether the new instability is also a threat: whether the other two economic time zones will be seriously unsettled by turmoil in this one. The apparent further deepening of Korea's plight last week should lead to some rethinking on both counts.
It was certainly a bad week. The Korean currency (the "won") fell on the first four days, and though it recovered a little on Friday, at 1,710 to the dollar it was still only half the value it was at the beginning of the year. Securities prices were back close to the year's lows. The US credit-rating agencies cut the rating on Korean debt, underlining the status of these agencies as a lagging indicator. And most seriously there was a flurry of contradictory stories about the position of the IMF-backed rescue package. Some focused on the supposed inadequacy of the funds available, others claimed the conditions imposed by the IMF were too tough, and others blamed the IMF for not recognising the seriousness of the problem earlier.
With a string of stories like this, things get a bit bewildering, so stand back a moment from the hubbub of the markets and focus on what we are really learning that might be new. I don't think there is anything happening that is unexpected or unusual. When a country seeks help from the IMF there is always a string of stories about the ability of the IMF to cope, the inappropriateness of the measures, the dangers of knock-on effects on other countries, the social strains and so on. This is absolutely standard.
Think back to Britain's most recent brush with the IMF, just 21 years ago. Half the Cabinet did not want to accept the IMF terms. There was a weak prime minister, James Callaghan, who initially did not side with the Chancellor, Denis Healey. Healey warned of "riots in the streets" if public spending was cut too much. The leftist commentators claimed the IMF terms were unreasonable - and once the economy was recovering, that the terms were unnecessary. But now that IMF-required correction of the government's economic policies is rightly seen as the great turning point in Britain's economic fortunes.
Korea is not only less important to the world economy than Britain was or is; the fundamentals are more favourable. Take the financial fall-out: the won may have halved in value this year (left-hand graph) but sterling, admittedly over a slightly longer period, fell from $2.40 to below $1.60. The stock market has fallen sharply (next graph), but by less than the FT index fell a couple of years earlier in response to the first oil shock and soaring inflation. Even the current account deficit, though around 6 per cent of GDP, is no worse than that of Britain at that period. As for public finances, the fiscal deficit is not a deficit at all: the government has been running a surplus of some 4 per cent of GDP for the last three years.
What you have in Korea, however, is a record of great volatility. You can see that in the current account shown below, or in the very high growth rates that were achieved: 8-9 per cent during 1994 and 1995. The IMF is seeking a growth rate of 3 per cent and this is being seen as imposing hardship. Three per cent is hardship? Most of continental Europe would have been thrilled with that over the last five years.
There is a problem servicing foreign- currency debt, nearly all of it in dollars, for if the won halves in value, the servicing cost doubles. Total foreign currency debt has, however, been cut from 50 per cent of GDP in the early 1980s (right-hand graph) to 25 per cent, and though it was actually down below 15 per cent in the early 1990s, this still should be manageable.
So why are people like the New York economist of Deutsche Morgan Grenfell telling the International Herald Tribune, "The truth of the matter is that Korea Inc is already bankrupt ... This is a zombie economy"? For exactly the same reason the Wall Street Journal headlined a story in 1976 "Good- bye Great Britain". It is always at the moment when people start to despair that the turning point occurs.
Actually I think the turning point for Korea may still be some way off, though not because of the macro-economic problem about which everyone seems to be panicking but which only needs three or four years of slowing growth with consumption held down and debts repaid. More serious is that there is a serious structural problem which has to be tackled: the close links between companies and banks and in particular the lack of market transparency about those links.
The so-called "Asian model" has been much admired in the West. Writers have praised the way in which the long-term relationship between companies and banks have forced savings into industrial investment. Meanwhile, the alleged short-termism of Anglo-Saxon finance has come in for plenty of criticism. The mantra "investment" is repeated time and time again by the Chancellor. And left-leaning think-tanks produce papers about "Asian values".
But what we have learnt from Korea (and to some extent Japan) is that too much investment is just as destructive as too little: money is forced into projects which at best never produce a decent return, and at worst lose money. The close links between banking and industry mean that if industry makes a mistake, the banks are dragged down. And the maligned Anglo-Saxon model actually seems to be much better at generating risk capital for start-ups than either the Asian or the continental models. As for "Asian values", well, there are values like hard work and thorough grounding in maths which are enormously helpful to the economy. But there are others which self-evidently are not.
Fixing this structural problem is enormously difficult because it means changing an entire set of attitudes. In fact I don't think the fundamental structure can be changed, so Korea will have to try and patch up its financial system by feeding in greater transparency, allowing a few more bankruptcies (but protecting bank depositors), and gradually establishing market signals as the best way of determining the wisdom of investment projects. This is going to be a 10-year slog: at the end the financial system won't be perfect, but it will be adequate.
Meanwhile, what about the damage to the rest of the world? I wasn't worried until Friday, for this seemed a regional problem rather than a global one. US and European markets certainly take this view: there will be slower growth in one of the three time zones, with some knock-on effect on the others. However, that will be compensated for by lower-than-expected interest rates everywhere. But on Friday Hans Tietmeyer, the Bundesbank president, said it was unlikely the crisis would spread beyond the Asian region. Now that is probably right. It ought to be right. But when central bankers start saying there isn't a problem, that is the time to start wondering if there might be one.
So maybe the best answer to my colleague's question is this. It wasn't too bad for us that Korea was doing well, for Korea was merely moving up the same ladder of economic progress that the developed world has done before it. To fear a country like Korea is to put an unrealistic importance on "Asian values". And it is not bad for us now because Korea will come all right in the end. We too went down that same path 21 years ago.
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