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Looming Financial Crisis in South Korea? A Review of ‘The Global Financial Crisis and the Korean Economy’

Once touted as an economic miracle, South Korea may be facing another financial crisis. More commonly associated with pop culture nowadays, South Korea is actually a country rich in history, culture and traditions. A staunch US ally in the Far East, South Korea was once ravaged by war and poverty but is today one of the wealthiest countries in the world and home to major manufacturers Samsung and Hyundai.

Situated in East Asia, South Korea is roughly the size of Maine and flanked by North Korea to the north, China to the east and Japan to the west. With a highly-educated population of about 50 million, the country experienced rapidly economic growth between the early 1960s and mid-1990s averaging about 10 percent of growth per year. Yet, in the last two decades or so, it was hit in relatively quick succession by two major financial crises. First, the country was struck by the Asian financial crisis in 1997-98 and then again, by the global financial meltdown in 2007-08. In both instances, not only was the Korean economy devastated, asset prices plummeted, bankruptcy rates soared and countless workers were laid off. Although the South Korean economy has since recovered, it is no longer growing at the kind of torrid pace experienced before the mid-1990s. Household debt, on the other hand, has increased significantly while corporate investments have stagnated. If history has a nasty habit of rhyming, then is South Korea doomed for another financial crisis?

The answer may be found in The Global Financial Crisis and the Korean Economy. Published by Routledge in late 2013, the book contains key insights into the workings of the global financial system as well as the complex nature of the Korean economy. Written by a noted Korean economist, it is definitely an important piece of work on these subject-matters. Carefully tracing the sequence of events that transpired during the 1997-98 and 2007-08 financial crises, author Shin Jang-Sup presents a revisionist view that readers will find both insightful and enlightening.

Then again, why should we care about a small country that is located thousands of miles away from the continental United States? After all, the South Korean economy is but one-tenth of the US’ and the country is not even a major US trading partner.

In my view, this provincial mentality is no longer tenable as the global economy is today deeply integrated and inter-dependent. Indeed, what happens in South Korea will most certainly have an impact on the US. It needs no mention that the 2007-08 global financial crisis actually started in the US and eventually spread to South Korea. If the South Korean economy were to collapse again, one can be fairly certain that the US economy would be affected one way or another. In short, we can no longer afford to ignore our external environments in today’s inter-connected world.

So will South Korea be facing a third financial crisis in the future? The answer is patent in The Global Financial Crisis and the Korean Economy. Shin delivers his central thesis clearly and one only needs to follow his sound logic to come to a definitive conclusion. Neither does the author hedge his thesis with caveats and equivocations but drives his point home unmistakeably. Moreover, since the author avoids using arcane economic jargons and onerous mathematical concept, readers of all levels of sophistication will appreciate his arguments with few difficulties.

In essence, Shin addresses the question of whether South Korea will be hit by another financial crisis by pointing out a plain and simple fact: South Korea was again hit by the global financial crisis in 2007-2008 even though it had restructured its economy in 1997-98 during the Asian financial crisis.

As mentioned earlier, the South Korean economy was a powerhouse between the early 1960s and mid-1990s, and Shin attributed this period of phenomenal growth to the country’s export-oriented model along with heavy investment by big Korean businesses. According to the author, this growth strategy is not only successful but also sound; otherwise, the Korean economy would not have grown as fast – transforming the country from a third world economy to that of a developed one within a few short decades.

But if the South Korean economy were fundamentally sound, then why did it fall into a crisis? The answer is straightforward – the collapse of the South Korean economy was caused by international financial speculation. Thanks to liberalization of the Korean financial market, international speculators were able to sell Korean stocks and the Won – the Korean currency – short. Short-selling is a financial term where a person sells an asset (such as a stock, currency or commodity) without owning it in the hopes of buying it back at a later date after a price drop. In times of global economic jitters, the Korean financial market is a natural target for international short-sellers because there are few measures in place to prevent rapid capital flights and currency attacks.

Indeed, South Korea has one of the most open financial systems in the world – arguably more liberal than those of the US. Consequently, the moment the global economy turns unstable, international speculators could immediately sell Korean financial assets en masse in the hopes of buying them back at a huge profit later. It is worth pointing out that 1997-98 Asian financial crisis actually started in Thailand before spreading to South Korea whereas the 2007-08 global financial crisis began in the US and spread to South Korea after Lehman Brothers collapsed. If the South Korean economy were fundamentally unsound, then it would be the first to fall into a crisis. But that was obviously not the case.

Even more significantly, countries facing the same predicament as South Korea were able to avoid falling into a financial crisis primarily because they had capital controls in place that limited speculative attacks on their financial system. Given the weight of the evidence, one can conclude that South Korea fell into a financial crisis not because its economy was unsound but because it had been an easy target for international speculators.

Shin’s central thesis is of course highly controversial as it directly challenges the conventional view that it was structural weakness in the South Korean economy – and not international financial speculation – that threw the country into economic and financial chaos in 1997-98 and 2007-08. For one, diehard proponents of financial liberalization will demand extraordinary proofs linking financial speculation to the collapse of the Korean economy in both instances. Unfortunately, in a complex world where prime causes are intertwined and often nebulous, the author may never be able to win over these critics.

Coming back to the question of whether South Korea will face another financial crisis, the answer is clear – unless policymakers in that country introduce financial controls to stem the sudden outflow of capital from the country’s financial system in times of economic uncertainty, South Korea will no doubt be hit by a financial crisis in the future. The question is really a matter of when. But if the future for the South Korean economy is patent, why haven’t policymakers in that country tackled the problem head-on?

To that, Shin alludes to deep vested interests – both international and domestic – that hamper South Korea’s ability to introduce capital controls. For some, a free and open financial system in South Korea is a cash cow and capital controls will only end that advantageous situation for them. Indeed, if capital controls were introduced tomorrow, the Korean stock market will almost certainly decline sharply as international investors liquidate their holdings. Even though capital controls might actually enhance stock market returns in the long run by reducing market volatility and reckless speculation, such measures inevitably drive down asset prices in the short run as international investors flee over fears that they might not be able to cash out in times of uncertainty. Needless to say, declines in asset prices – albeit a temporary one – hurt international investors and domestic investors alike and thus, presents a strong disincentive for powerful vested interest groups to back capital controls. Absence their support, capital controls will never be adopted as these interest groups wield immense influence over the country and internationally. As long as there is a mismatch between the long term interests of South Korea and the agendas of vested interest groups over the issue of capital controls, the country shall remain vulnerable to financial attacks by international speculators.

Lastly, The Global Financial Crisis and the Korean Economy contains an important message. In my view, the author is tacitly warning policymakers in the US that the international financial system, as dominated by the International Monetary Fund or IMF, is broken. As the IMF demands nothing short of full market liberalization (in both finance and trade) from countries in need of its aid, the international financial system has become more unstable than ever since the last financial crisis in 2007-08. As the case of South Korea illustrates, even countries with sound economies are no longer safe from international speculators, sudden capital flights and currency attacks. While international speculators reap huge profits from their activities, countries face certain ruination.

Increasingly, countries that have witnessed the devastating effects of the 1997-98 and 2007-08 financial crises are questioning their longstanding ties to the US due to her backing of the IMF. Even more troubling, these countries are starting to look to Beijing for leadership and security as China rises to rival the US. If this trend continues, the US could one day find herself with few allies in times of major crises.

In all, The Global Financial Crisis and the Korean Economy is an insightful book that contains a very powerful message – a warning even – that the US should no longer ignore. Well-researched, the book is highly-informative and clearly written. For those looking to understand the South Korean economy, its future and the international financial system, The Global Financial Crisis and the Korean Economy is definitely a must-read.