Economic Scene: South Korea Facing Difficult Economic Choices

Economic Scene: South Korea Facing Difficult Economic Choices

by Peter Passel

For the moment, Korea-watchers are relieved: Both the currency and stock markets have regained some of the ground they lost in last week's nightmarish plunge. And all the candidates in Thursday's presidential elections seem to have made their peace with the strings the International Monetary Fund has attached to its $57 billion-plus rescue package.

But that is hardly the end of the story. Much of what the IMF, with strong support from the Clinton administration, is demanding from Seoul is the free marketer's equivalent of mom and apple pie: a restructuring of the financial system to make it more competitive and more resistant to shocks, along with an opening of trade and an easing of rules limiting direct foreign investment.

Wednesday, South Korea made an important step in meeting those demands, putting off plans to subsidize six of the nation's biggest banks.

However, much remains controversial. To bring back foreign capital and reverse the depreciation of the Korean won, the IMF is also calling for high interest rates and fiscal austerity. And while relatively few economists concur with Jeffrey Sachs, director of Harvard's Institute for International Development, that "the IMF's seal of approval is a seal of doom," there is deep uneasiness that austerity will push Asia into recession and political instability.

"The IMF is substituting a technical fix for more flexible treatment of a rapidly changing political problem," said Albert Fishlow, a senior fellow at the Council on Foreign Relations.

It is no mystery what went wrong in South Korea. Backed by a seemingly limitless supply of cheap loans from government-controlled banks, a few dozen politically connected conglomerates have long dominated the industrial landscape. They grew at an incredible pace along with the economy. But with the conglomerates' equity stretched paper-thin and the banks deeply in debt to their counterparts in Japan, South Korea's capital market was vulnerable to the currency turmoil that has whipsawed Asia.

Nor is there much mystery about how South Korea must change to complete the journey to economic maturity. The conglomerates need to be restructured, leaving them with less debt and more managers who measure success in profits rather than market share. Insolvent banks must be liquidated or merged with foreign banks. Others must tidy their portfolios, exchanging short-term liabilities for long-term debt that is less subject to speculative meltdown. Most of all, South Korea must make the leap from planning to decentralization with few barriers to entry for domestic or foreign competitors.

What complicates this rescue is the need to stop capital flight by restoring international confidence. The IMF, taking a leaf from the play book it has used from Bolivia to Ukraine, is prescribing high interest rates along with a tight budget to amass the cash needed to pay off depositors in failed banks.

Paul Krugman, an economist at MIT, acknowledges that tight credit is probably a must. "If stabilizing the exchange rate is important, what is the alternative?" he asked. But he balks a bit at imposing fiscal austerity, which will throw hundreds of thousands out of work and may push the economy into recession.

Sachs does not share his ambivalence. With South Korea's exceptionally high savings rate and high-technology industrial sector, he adds, it is folly to call for policies that reduce consumption and investment -- and thereby force it to export more deflation from a continent already flooded with surplus goods.

In Sachs's view, the United States and Japan should have moved quietly months ago to stem panic in the South Korean currency market, in essence acting as lender of last resort to an illiquid but basically solvent economy.

Krugman doubts that would have been possible in light of Japan's preoccupation with its own financial problems and the U.S. Congress's post-cold war inclination toward navel-gazing. But he does wonder whether it would not have been better to let South Korea declare a moratorium on foreign debt repayment while it moved swiftly to cleanse the balance sheets of the banks and conglomerates.

The unspoken idea of the hour is "capital controls." The IMF is deeply committed to mobilizing international capital, reducing risk for investors and pressing countries to open markets at virtually any cost. Restraints on currency convertibility, the thinking goes, are an excuse for recidivism.

But with hindsight from the Asian currency mess, it appears that the best way to get from here to there may not be the most direct way. If the crisis deepens, involving Japan and China in competitive currency depreciation, even the high priests of global capitalism may wish to rewrite their catechism.