The Asian Financial Crisis and Korea's Transformation Efforts

The financial crisis that started in Thailand in July 1997 hit the Korean economy at the end of 1997. Although the causes of the financial crisis might be manifold, it has been generally agreed that the crisis derived from structural weaknesses, which included mismanaged financial sector and over-leveraged chaebols. On November 21, 1997, the Korean government requested IMF for an emergency rescue loan of 55 billion dollars to address the nation’s liquidity problem. As a condition for the IMF bailout loan, Korea had to adhere to the IMF-mandated programs, including tight fiscal and monetary policies, financial and corporate sector reforms, and further liberalization of trade and capital flows.

The crisis of 1997-1998 was considered by the Koreans the worst crisis since the Korean War. Since Korea just entered the OECD in the previous year, the outbreak of the crisis came as a shock to the Koreans. Throughout 1998, the Korean economy experienced a sharp economic contraction. Actual GDP fell by 5.8 percent and the consumption dropped 8 percent. The crisis has painfully affected the economic life of the Koreans. It caused the bankruptcy of banks and chaebols, the drastic downsizing of surviving companies, consequent high unemployment. Although the Korean firms had practiced Japanese style life-long employment management, they laid off many workers including engineers in high-tech industries in the wake of the crisis.

Despite the negative effects of the crisis, Korea has made some strides in altering various critical elements in its system since the crisis. The IMF crisis made Korea question the foundation of the Korean economy and reshape development strategy. The 1997 financial crisis triggered the government to undertake policy reforms as part of a broader movement toward a more open market-oriented system. The crisis prompted the government to restructure its administrative apparatus for improving the productivity of the government sector (e.g., coordinating public science and technology efforts). The government intensified chaebol reforms, which included the reduction of debt to equity ratios to below 200 percent and the dismantling of cross-credit guarantees among subsidiaries. Chaebols were also pressed to improve their corporate governance system. Moreover, the government accelerated financial liberalization to attract foreign investment and participation. The Asian crisis resulted in a noticeable increase in FDI.

The reform efforts are still unfolding. The Korean economy including export growth had steadily improved till the current global economic contraction. The Asian financial crisis catalyzed industrial restructuring in Korea. For one thing, owing to downsizing in chaebols and the promotion of venture companies by the government Korea saw a major surge of high tech start-ups. Nonetheless, even if some progress was made in reforming the financial and corporate sector, Korea still has a long way to go to transform Korea’s outmoded economic and innovation systems. Socio-economic factors that have impeded the balanced social and economic development and the well-being of the Korean society remain unchanged to some extent. Periods of crisis could have been the best time to implement serious reforms. Korea could have emerged with stronger fundamentals than before in post-crisis years.