This is an electronic version of an article published in New Political Economy, Vol. 13, No. 4, December 2008, ISSN 1356-3467 print; ISSN 1469-9923 online published by 2008 Taylor & Francis It is available online at: http://dx.doi.org/10.1080/13563460802436616 If you would like to cite this paper please access the published version at or contact me at tkalinowski@ewha.ac.kr Author: Thomas Kalinowski, Graduate School of International Studies, Ewha Womans University, 11-1, Daehyun-dong, Seodaemun-gu, Seoul, 120-750, Korea, Webpage: http://home.ewha.ac.kr/~tkal Korea’s Recovery since the 1997/98 Financial Crisis: The Last Stage of the Developmental State THOMAS KALINOWSKI In this article, I challenge the view that Korea‟s successful macroeconomic recovery from the 1997/98 financial crisis was the result of market-oriented reforms and International Monetary Fund (IMF)-prescribed structural adjustments. I show that the recovery was mainly achieved by the „traditional strengths‟ of the pre-crisis development model, resting on export orientation and strong state capacity, rather than a transformation into a new „neoliberal‟ state. However, I also show that economic liberalisation and market reforms undermine state capacity and restrict a proactive and developmental role of the state. In short, the successful recovery was the last stage of the developmental state in Korea. The article is organised as follows. In section one, I provide a critical review of the relevant literature on Korean post-crisis restructuring and present my argument in more detail. In section two, I show that the main contributor in stabilising the economy and replenishing foreign currency reserves was Korea‟s exports, and not the process of regaining foreign investors‟ confidence through market opening and financial liberalisation. In section three, I illustrate the importance of state intervention for the economic recovery of Korea and, in section four, I argue that this state capacity is a product of the Korean developmental state, which has slowly been undermined by market-oriented reforms. I conclude in section five that Korea‟s successful recovery has been based on the two pillars of export orientation and state expansion, which face internal and external limitations, making a similar strategy unviable for other countries and even for potential future crises in Korea. Korea since 1997: restructured or remodelled? The IMF, World Bank and the majority of economists praise Korea‟s successful recovery from the 1997/98 financial crisis as a result of the strong commitment of the Korean government to depart from previous interventionist government 1 policies and restructure Korea into an open market economy with an efficient regulatory state. In this view, the role of the state is reduced to providing a framework for the market and allowing government intervention to take place only in the exceptional case of market failure. This „official version‟ claims that Korea overcame the crisis because it was able to regain „market confidence‟, reversing the outflow of foreign capital and luring investors back to Korea.1 This is consistent with the IMF‟s analysis of the causes of the crisis, seen as the result of foreign investors losing their confidence in the Korean economy because the Korean model of a strong developmental state had become anachronistic. Too much state intervention in the economy („crony capitalism‟) was seen to have undermined the functioning of market forces and led to the crisis. Adherents of the developmental state theory criticise this „official version‟ of events and argue that the dismantling of the developmental state through economic liberalisation is what contributed to the crisis in the first place, by creating a regulatory vacuum that led to the unsustainable inflow of foreign capital.2 I generally agree with the developmental state theory‟s view of the economic development of Korea leading up to the crisis.3 Indeed, since the publication of the East Asian Miracle by the World Bank in 1993, the importance of public policy in East Asian development has been widely acknowledged and criticism has been directed not towards the effects of the developmental state in the past, but rather its applicability for the present and future.4 However, the developmental state perspective has limits in explaining the economic recovery since 1998. If the dismantling of the developmental state was responsible for the crisis, how could accelerated market reforms under IMF-sponsored structural adjustment be reconciled with the successful recovery? In fact, many proponents of the developmental state theory dispute that there has been a recovery at all. They claim that despite the average real growth rate of more than 5.5 per cent from 1999 to 2007, social inequality and poverty have increased5 and corporate investments remain much lower than before the crisis.6 However, although it is true that the domestic economy in Korea remains weak and social inequality has increased dramatically, the successful macroeconomic recovery cannot be ignored and deserves explanation. In contrast to the „recovery pessimists‟ of the developmental state camp, Linda Weiss provides an interpretation for Korea‟s successful recovery that is consistent with developmental state theory. Weiss argues that the developmental state is largely still intact and that market reforms were shaped by an active state in a typically „Korean way‟. Market-oriented reforms remained shallow and merely remodelled the developmental state.7 Steven Vogel uses a very similar argument to account for the slow and idiosyncratic implementation of market reforms in Japan.8 Vogel and Weiss thus highlight the path dependency of East Asian capitalism and reject the hypothesis that different forms of capitalism have been converging on an Anglo-American style of „free market capitalism‟. Iain Pirie, on the other hand, opposes the path dependency argument and contends that there has been a convergence of capitalisms. He claims that Korea has become a „new‟ neoliberal state that is very similar to US-style capitalism in its regulatory changes, such as improved shareholder rights and, in particular, the new independent central bank.9 Pirie is correct in claiming that the state acted as midwife to more unfettered markets, but Korea is still far from becoming an economy that is driven by market competition and financial investors. Weiss correctly argues that many of the changes Pirie describes remain at the regulatory level, and have not transformed the underlying institutions. 2 In this article, I provide further support for the hypotheses of Weiss and the „remodelling‟ camp which highlight path dependency and the continuous importance of the state. I argue that the two traditional strengths of the Korean development model – export orientation and a strong state – helped the country to recover successfully. I show that market confidence and foreign investors returned to Korea only after massive state intervention and exports had stabilised the economy. It is not surprising that exports played a pivotal role in Korea‟s recovery given the traditional strengths of the export sector and the massive devaluation of the Korean currency during the crisis. The export-oriented recovery does not contradict the IMF‟s interpretation of the events. Most observers, including the IMF, acknowledge the role of exports, yet overrate the role of the currency devaluation in the export-led recovery and underestimate the role of structural strengths in the export sector. Exports were crucial for the recovery by helping accumulate foreign currency reserves, but this cannot explain the restabilisation of banks and financial markets. Here, the strong state, the second „traditional strength‟ of the Korean developmental model, allowed the government to intervene directly in the financial markets in order to refinance and restructure the financial sector, as well as to socialise the costs of the crisis, unlike many other developing countries. I adopt Theda Skocpol‟s concept of state capacity, where state capacity is based on sovereign integrity, loyal and skilled officials, and financial resources.10 The sovereign integrity of Korea and the loyalty and skills of Korean officials have not been questioned during the crisis and are not of particular concern here. The financial capacity of the state, on the other hand, was pivotal during the crisis when the Korean economy became illiquid in 1997. The initially low public debt level obviously provided the state with the fiscal capacity to cope with the crisis. Expanding upon Skocpol‟s definition, I am arguing that the political capacity to deal with the crisis was at least equally important. Political capacity derived from the relatively strong legitimacy of the state in Korea, which can be attributed to the tradition of a strong state in Korea, as well as the process of democratisation since 1987. The developmental state derived „embedded autonomy‟ due to its authoritarian nature and the weakness of social groups.11 Since the 1980s, this authoritarian autonomy has vanished. First, the large business conglomerates (chaebol) emerged as an independent interest group and stopped following the government‟s economic plans. Since 1987 organised labour and the democratic movement have powerfully claimed freedom from authoritarian rule and helped at least partially to balance the overwhelming power of the chaebol. The state lost its authoritarian autonomy during this process of „double emancipation‟ and in the 1990s the chaebol‟s interest dominated the public discourse and government policies. However, labour unions and other civil society organisations prevented a complete capture of the state by the chaebol and during the financial crisis the struggling chaebol lost much of their credibility and dominance. The state regained democratic autonomy, deriving from a „class compromise‟ and embedded in a balance of power between diverse social interest groups. I generally follow the „remodelling‟ argument, but also depart from it as I believe that Ha-Joon Chang, Weiss and other scholars from the developmental state tradition overestimate the feasibility of future strategic developmental policies. The role of the state in Korea is increasing and the state remains important to facilitate market reforms, but it is very likely that the market-oriented reforms represent the last stage of the developmental state. Industrial policies still play an important role in supporting Korea‟s drive into the information technology (IT) sector, as Weiss shows, but state interventions in the late 2000s are very different 3 from what they were during the heyday of the developmental state. State interventions are becoming less and less strategic and more and more reactive, mitigating the economic and social costs of market-oriented reforms. Thus, the state is getting bigger, but at the same time weaker. It is less strategic, and less associated with „midwifery‟ than with a „nursing‟ function – feeding the losers of market reforms and cleaning up the mess when markets get out of control. Scholars in the tradition of developmental state theory overrate the potential of the state to sustain strategic interventions in the future. The successful state-led recovery, together with the implemented market reforms, is severely undermining the developmental and crisis-solving potential of the state. As Pirie notes, these undermining processes are institutional because decision-making processes are delegated to independent institutions such as the central bank or subsequently taken over by market actors.12 It is still too early to evaluate these institutional changes and it remains to be seen how the new „market-friendly‟ institutions will function when they are tested under pressure. Nevertheless, it is clear that any attempt to return to an old-style developmental state has to fail, because it would require getting the chaebol back under the control of the state. This is hardly imaginable, as the largest chaebol took advantage of the market reforms and transformed themselves into formidable global players. A second trend undermining state capacity is already becoming more obvious. The immense costs of the crisis management have undermined the fiscal and political capacity of the government. A dramatically increased government debt and a higher tax rate leave little room for expensive „Korean-style‟ recoveries in the future. More importantly, the government, and the political class in general, has lost much of its political credibility. Market-oriented reforms have revitalised the economy but many Koreans are now worse off than before the crisis, having switched to less secure „irregular‟ jobs or precarious self-employment. Notably, many labour unions and non-governmental organisations (NGOs) regret their general support for the restructuring since 1997 and it is unlikely the government would be able to count on such support for restructuring in the future. This tendency of market reforms to undermine state capacity also questions the IMF‟s attempts to present Korea as an example of successful structural readjustment.13 If even Korea is not likely to be able to repeat its own successful recovery, it is unlikely that poorer developing countries with less capable states would be able to follow Korea‟s example. Recovery through export orientation The core of IMF reforms, in Korea and elsewhere, is to regain „market confidence‟ by carrying out „market-friendly‟ reforms.14 These rather vague terms mean that policies should focus on attracting foreign investment by carrying out investor-friendly reforms. In the IMF‟s view, market confidence can be achieved by reducing the barriers for capital to enter crisis countries and increasing the return on invested capital through supply side-oriented reforms. In the case of Korea, the IMF did not even need to apply pressure to the government to liberalise the financial market – the government opened the financial market even faster, and more radically, than the IMF requested. For example, limits on foreign investment in listed companies were first loosened and subsequently completely abolished in May 1998 – seven months ahead of the IMF‟s schedule.15 To increase the return on foreign investment, the IMF demanded interest rate hikes and the rationalisation of corporate governance. However, „investorfriendly‟ policies did not help trigger Korea‟s initial recovery from the crisis. 4 Rather, they had the opposite effect, as high interest rates signalled to investors that Korea was in trouble and panic grew even wider. High interest rates also transformed the financial crisis into an economic crisis, as companies went bankrupt or were forced to introduce rationalisation measures, resulting in massive lay-offs and widespread unemployment. The repercussions of interest rate hikes have been widely criticised and thus it is not necessary to repeat this discussion here.16 Rather, the relevant issue is how Korea was able to recover in spite of these initially disastrous results. Investor confidence was finally regained in 1999, but only after strong exports had already boosted Korea‟s foreign currency reserves and massive state intervention had stabilised the economy. During the three years of the IMF structural adjustment programme, beginning in December 1997, approximately 95 per cent of the net inflow of foreign currency reserves came from exports, while capital inflow in the form of portfolio and direct investment was insignificant, and even negative in the case of credits.17 Without question, foreign investment has increased and has played a role in the refinancing and restructuring of individual companies, as Elizabeth Thurbon and Linda Weiss point out.18 Whatever the contributions of foreign investment to the long-term development of individual companies might have been, the inflow of foreign capital did not play a major role in the immediate recovery of 1998/99. Since the crisis, Korea has reverted to a state of extreme export dependency, which was characteristic of Korean development until the 1980s. Export dependency, measured as the export share of gross domestic product (GDP), increased from 23 per cent in 1996 to 38 per cent in 1998. Since then, the share of exports has fluctuated between 30 per cent of GDP in 2002 and 37 per cent in 2006.19 This ever-increasing export orientation was triggered by the devaluation of the Korean currency, which made exports more competitive and imports more expensive. However, dramatically increasing exports could not have been achieved without a strong export industry already in place before the crisis. Korea managed to recover because it had a strong and relatively diversified export economy. Most developing countries depend on exporting agricultural products, raw materials or a few labour-intensive manufactured goods. Korean chaebol, on the other hand, managed to acquire an impressive market share in industries such as ship building, cars, semiconductors, electronic appliances and IT. Thus, from 1998 onwards Korea was able to profit from the upswing of the US economy and the „new economy‟ boom that led to surging demand for many Korean export products. Much of the capital that was withdrawn from East Asia during the crisis fuelled the „new economy‟ bubble around the world. Ironically, the transfer of capital that triggered the crisis also helped to overcome it, at least for IT exporters such as Korea. The recovery since 1998 was not achieved mainly by a transformation into a new market-oriented system, but rather by reverting to strategies of the past. Export orientation has indeed been one of the important engines of Korean development since the 1960s. This gradually changed when the process of democratisation began in 1987 and Korea‟s employees demanded their share of the pie. Domestic mass consumption led the economy into a dynamic new phase of development. Korea became recognised as one of the few developing countries that eventually managed to start transforming itself into a domestic mass consumption-driven „Fordist regime‟. However, this transformation has since been challenged by the crisis of 1997/98 and the subsequent supply side-oriented reforms. The high dependency on exports reveals the weakness of the domestic 5 economy, with low levels of investment and domestic consumption. Domestic investment is limited by the stricter „market-based‟ lending criteria of banks. Domestic consumption has decreased due to increasing social cleavages and the growing sense of social insecurity amongst the public. Within a decade after the crisis, Korea had evolved from a country that was applauded by the World Bank for achieving „growth with equity‟ to one of the most socially unequal societies within the Organisation for Economic Cooperation and Development (OECD).20 The weakness of the domestic market from 1998 was only interrupted by a brief recovery in 2001/02 that was fuelled by credit-financed consumption. Since banks had to meet higher standards to provide loans to companies, they focused on lending money to private households by distributing credit cards without any safeguards. By the late 2000s, over 89 million credit cards had been issued in Korea. The government also supported credit card use by providing tax breaks in order to strengthen domestic consumption. The combination of risky government and management decisions with a consumption mania led many lowincome households directly into insolvency. Currently, there are 4 million Koreans on the „black list‟ of credit card companies.21 The high level of credit card delinquency triggered a crisis in the credit card industry. In 2003/04 the biggest credit card company, LG-Card, went bankrupt and had to be bailed out by the stateowned Korea Development Bank. It is highly unlikely that the domestic market in Korea would be able to function as an engine for Korean economic development in the near future. Increasing private domestic demand would require higher wages or more redistribution and social security spending. Given the weakness of Korean labour unions, wage increases for the majority of employees are not realistic, other than for regular employees of certain large companies. There is a lack of political forces aiming for or even envisioning such a major transformation away from export orientation and towards a more balanced economy. The problem of export-led recovery and development is that it is not sustainable for a longer period, because export surpluses create deficits in other regions. Since the 1990s, the US current account deficit has absorbed surpluses in East Asia – a trend that cannot continue indefinitely. Trade surpluses usually lead to an appreciation of the currency of the surplus country and thus undermine international competitiveness. Indeed, the Korean central bank had to intervene constantly in order to prevent the Korean currency from appreciating. As a result, Korean currency reserves are surging and surpassed $260 billion in 2008. In effect, this form of state intervention has helped finance the US current account and government deficit as currency reserves are mostly held in US treasury bonds. At the same time, the accumulation of currency reserves is a form of state subsidy to the Korean export sector as it keeps the Korean currency competitive and indirectly helps finance the consumption of Korean products in the USA. The two most important export markets for Korea are the People‟s Republic of China and the USA. The USA is the second biggest market for Korean products, but its status as such has become a major source of uncertainty due to the enormous US trade deficit of over $800 billion. It is difficult to estimate when and how this deficit will decrease, but inevitably it must. The weakening of the US dollar against the Korean currency since 2005 has been making Korean imports more expensive in the USA and has reduced the price of US exports. The subprime mortgage crisis and a possible recession in the USA have also reduced the chances of increasing exports. At the same time, rising oil and commodity prices have increased the price of Korean imports. When all these factors are taken into 6 account, it is obvious that export-led growth has become less and less feasible, and it is no surprise that the Korean current account swung into a deficit in early 2008. Proponents of the „decoupling‟ hypothesis predict a resilience of East Asian economies amidst a US slowdown.22 They argue that China has become more important as an export market than the USA, but this is only partly true. Many products formerly exported directly to the USA are now simply assembled in China from Korean-made parts and then exported to the USA. Similarly to Korea, China‟s growth has been based not on domestic consumption but on exports that depend heavily on the USA as the „consumer of last resort‟. Thus, the decoupling theory is not convincing and it is likely that East Asia will experience major challenges from a reduction of the trade deficit and an economic slowdown in the USA. In the last decade, the economic rise of China has provided Korea with new export opportunities, but the Chinese economy remains fragile and growth rates will eventually decline. Even more dangerous could be the bursting of the bubble that is growing in the Chinese economy due to excessive speculative capital inflows betting on an appreciation of the currency. Until now, Korea has profited from China‟s rapid economic growth and its growing demand for Korean products, but in the future China is likely to become a serious competitor, taking away market share from Korean companies. Korean imports from China will increase, narrowing Korea‟s current account surplus towards China. In this context, it is also important to note that Korea became the biggest foreign investor in China in 2004, which indicates massive outsourcing from Korean companies and will result in increasing (re-)imports from China.23 So far, the decoupling theory has no solid empirical foundation, but it has some plausibility for the short-term outlook. Oil and commodity exporters profit from a surge in prices of their products and Korea‟s diversified export industries are in good position to satisfy the increasing demand in the consumer, transportation and construction sectors. However, to a large extent, the boom in oil and commodity prices are fuelled by a speculative bubble, created by frantic investors seeking new investment opportunities amidst slowing economies in more advanced countries. It is doubtful that commodity exporters will be a reliable export market for Korean products. The only remaining plausible substitute for the USA as the consumer of last resort is the European Union (EU). So far, Korean companies have been weak in penetrating the European market and it remains to be seen if the EU will accept trade deficits comparable to the ones experienced in the USA. The main engine of the Korean economy is thus sputtering as the current account surplus is vanishing. However, contrary to the IMF‟s observation that Korea has been „flying on one engine‟,24 the expansion of government activities has kept the country from crashing. State-led, not market-led recovery As noted earlier, the IMF and the „official version‟ of recovery and reforms in Korea is that they were led by the market and differ radically from the pre-crisis state-led development. IMF structural adjustments strongly support economic liberalisation, deregulation and „market-driven reforms‟. In this view, state interventions are only justified in reaction to market failure or are considered to be an undesirable „hangover‟ from the period of state-led development. I challenge this „official view‟ and maintain that, in the case of Korea, IMF reforms have been deeply interwoven with the overall increasing role of the state, although the 7 trend is contradictory as the state withdraws in some fields and expands in others. The old-style developmental state in Korea is dead, but this does not mean that the role of the state is declining. On the contrary, it is increasing in size although aims and content of policies are changing. The old developmental state was concerned with economic growth and developing an industry structure, while the new remodelled state is concerned with creating a framework to externalise costs from the economy in order to ensure profitable investments in the private sector. While the active planning of development declines, the role of the state shifts into a reactive cleaning up of the negative effects of crisis and reform in order to make Korea attractive for international investors and tame social discontent. In this process, the size of the state has increased. General public spending grew from 28.8 per cent of GDP in 1997 to 32.6 per cent in 2000 and 35.6 per cent in 2003. The tax burden increased from 19.5 per cent of GDP in 1997 to 21.8 per cent in 2000 and 22.8 per cent in 2003. Government debts increased from 7.5 per cent of GDP in 1997, to 16.3 in 2000 and 18.7 in 2003.25 If government-guaranteed debts are included, the figure is even higher at 42 per cent of the GDP in 2001, up from 16 per cent in 1997.26 While these figures are still relatively low compared to other OECD countries, the surge of government debts in such a short period is remarkable. The interaction between economic liberalisation, privatisation and state intervention can be observed best in the financial market reforms in Korea. Major parts of the financial systems were nationalised during the crisis and there were frequent government bailouts. It is a paradox that, although the IMF promotes privatisation and market-driven reforms, at the end of the structural adjustment programme in 2000 around 54 per cent of banking capital was controlled by the state, up from 33 per cent before the crisis.27 While the IMF and the government systematically opposed bailouts and tried to limit direct state intervention in the economy, the economic situation made massive state intervention inevitable to prevent another crisis and make financial institutions attractive for foreign investors. Since 1998, the financial market in Korea has appeared to suffer from „permanent market failure‟, necessitating frequent government interventions. The banking crisis in 1998 was followed by the bond market crisis in 1999, the stock market crisis in 2000 and finally the credit card company crisis in 2003/04. It is still not clear if the US mortgage crisis that emerged in 2007/08 will spread to Korea, but, given the massive housing price bubble and the high level of mortgage debts, it is unlikely that the financial sector will be completely spared. The recovery was based on socialising debts and a shift of responsibility from private investors to the tax payer in order to regain systemic stability. From 1997 to 2001, the government invested more than 150 trillion Won (at that time around US$135 billion) to stabilise the financial market by socialising private debts. This amount is equivalent to 32 per cent of Korean GDP. If the „recycled money‟ that has been earned by privatisation since then is taken into account, the costs remain at 22 per cent of GDP, which still makes the financial clean-up in Korea one of the most expensive in recent history.28 There are more examples illustrating the complex relationship between economic liberalisation and state intervention, such as in the labour market and social security. To help rationalising businesses, the government liberalised labour laws and lay-offs of workers were made easier in order to increase labour market flexibility for employers. To compensate employees for growing insecurity, the government promised to liberalise regulations regarding labour unions and to 8 strengthen the social security system. In practice, most large-scale strikes in Korea since 1998 have been declared „illegal‟ by the government and often dissolved by the police. Arrests of labour unionists for organising labour protests even increased during Kim Dae Jung‟s presidency (1998–2003), although he was touted as a pro-labour candidate. The government constantly intervened in labour struggles on the side of employers and at the same time attempted to mitigate the social costs of economic reforms by improving the social security system. As a result, welfare spending increased substantially, from 3.6 per cent of GDP in 1996 to 5.7 per cent in 2003, although this is still far less than in any other OECD country.29 By building up a welfare state, the government explored a completely new field for increasing government intervention and spending. The government not only mitigated the negative social effects of market reforms but also their negative economic effects. Market liberalisation led to an even greater concentration of market power in the hands of a few large chaebol. They were allowed to enter markets that were previously the exclusive domain of small and medium-sized enterprises (SMEs) and gained nearly unlimited access to international financial markets. SMEs, on the other hand, face increasing competition from the chaebol and foreign competitors, while banks are reluctant to provide risky credits to SMEs. Instead of protecting SMEs from the chaebol and ordering banks to provide loans to them („policy loans‟), the government is now forced to support SMEs by subsidies, credit guarantees and investments in infrastructure. The IT industry profited particularly from this direct government engagement.30 Another example of the interaction between liberalisation and state intervention is in exchange rate policy. When Korea‟s central bank became independent and fixed exchange rates were abolished after the crisis, Korea switched to a system of managed floating. Interventions in the exchange market have become increasingly important to improve international competitiveness. The Korean central bank is building up reserves, which reached $239 billion at the end of 2006. Korea now ranks fifth in reserves, just after China, Japan, Taiwan and Russia. These reserves protect Korea from another foreign exchange crisis as in 1997/ 98 and prevent the Korean currency from appreciating against the US dollar. Thus, Korean exports remain competitive and stabilise the economy. However, since the end of 2004, this trend has reversed and the Korean currency has appreciated, substantially harming exports. Economic liberalisation went hand in hand with massive state intervention and expansion. In some areas the role of the state decreased, while it increased in other areas. The currency peg was abolished and the regulation of foreign capital inflow was liberalised, but interventions into currency markets by the central banks have increased. Government protection of employment is weakened, but welfare spending increased substantially. In the field of industrial policies, the government stopped directly ordering banks to finance certain sectors of the economy. On the other hand, the government now provides credit guarantees and direct subsidies for sectors such as IT. In the past, development was financed by governmentdirected policy loans, whereas now it is supported by direct government subsidies and guarantees. Why was Korea able to achieve a state-led recovery? An active and expansionary state was crucial for economic recovery. But why was Korea able to achieve this state-led recovery when many other governments in similar crises failed? At least two features of the Korean state were pivotal in 9 providing the capacity to manage the crisis. First, Korea had the fiscal capacity to socialise the costs of the crisis. As we saw earlier, the initial debt level in Korea was very low. Thus, the government was able to use vast amounts of public funding to stabilise the financial system and expand government spending in general. Secondly, the government in Korea, at least initially, held the trust of its citizens and thus had the political capacity to manage the crisis. While painful economic restructuring created political chaos in crisis countries such as Indonesia (in 1997/98) and Argentina (in 1999–2001), protests in Korea never threatened the stability of the government. The government was able to place the burden of the costs of adjustment on the public without facing massive opposition because Koreans were willing to make sacrifices in order to achieve national recovery. Economic recovery became the „national goal‟ and the government took advantage of this strengthening nationalism, caused by the crisis situation. Confidence in the government to manage the crisis was stronger in Korea compared to other crisis countries. This can be seen, for example, from the differing reactions to the bank deposit guarantees announced by the government. Directly after the outbreak of the financial crisis across Asia in 1997, the governments of all affected countries guaranteed bank deposits in order to avoid a run on the banks. However, Thai and Indonesian savers still rushed to secure their savings and exchange them into dollars. Similar behaviour occurred later in the Argentine crisis. In contrast, most Korean savers did not withdraw their money from banks, because they trusted the state guarantees. Many Koreans even brought their own reserves, such as gold and dollars, to the banks in order to „save the national economy‟. Two factors can explain the initial trust of Korean citizens in their government to manage the crisis in a competent and just way: the experience of a successful developmental state until the 1980s, and the process of democratisation since the 1980s. Firstly, in contrast to Latin American countries, Koreans experienced a long history of successful government-planned economic development from the 1960s until the 1980s. This experience created trust in the capability of the government to manage the economy, even during challenging times. Most citizens perceived structural adjustments and market-oriented reforms merely as a new government strategy to achieve economic growth and higher living standards, just like the five-year plans for industrialisation during the military dictatorship. The experience with a successful developmental state created legitimacy in guaranteeing high economic growth rates that benefited the large majority of people. Even after two decades of economic liberalisation, the expectations that the government would manage the economy in the „national interest‟ remained strong. Secondly, democratisation since the 1980s provided Koreans with the power to elect a new government. Koreans elected a new president just two weeks after the outbreak of the crisis. Incoming President Kim Dae Jung gave the recovery strategy a legitimacy that the old Kim Young Sam government (1993–98) was not able to provide, because it was largely held responsible for the crisis. The fresh start allowed by democratic elections was in stark contrast to crisis countries such as Indonesia, where the dictator Suharto failed to generate support for his crisis management strategy and was overthrown by mass protests in 1998. Through democracy, Koreans felt responsible for their own country, liberating themselves from the military oppression in the 1980s. Democratic elections provided the government with unprecedented legitimacy and created a remarkable political stability. President Kim Dae Jung and his successor Roh Moo Hyun both served the full five years of their terms, even though they did not have a majority in parliament 10 during most of their tenure and were frequently forced to reshuffle their cabinet members. Argentina, in contrast, had five different presidents during the economic crisis from 1999 to 2001. Regardless of whether market reform policies in Korea during the IMF era are evaluated as successful or not, the fundamental changes have not politically destabilised the country. This distinguishes the Korean development from 1997 from many other structural adjustment processes in other crisis countries. The Kim Dae Jung government tried to generate new confidence in state capacity by substituting the fading allocation capacity of the developmental state with a redistributing welfare state, as we have seen above. Unfortunately, the improvements of the welfare state were hesitant at best, and the government failed to present the welfare state as an alternative vision for Korea. Welfare contributions were perceived as an increasing tax burden, while the services offered by the welfare system were either accessible only to the very poor or remained very limited. The national health insurance system, for example, offered a universal health insurance, but co-payments were very high. Whereas political stability and capacity were initially high, there is much evidence that the state capacity was undermined by the market-oriented reforms. The diminished state capacity reached an extent where future „Korean-style‟ recoveries have become unfeasible. Firstly, the fiscal capacity to mitigate the costs of potential future crises has deteriorated, as we have seen above. Secondly, the political capacity of the government to create political support for its crisis management strategy has also been undermined. The experience of a successful developmental state and the process of democratisation provided the government with the trust of the people to manage the crisis. However, market-oriented reforms undermined the actual capacity of the state to guarantee high growth rates and the gap between the expectations of citizens and the actual capacity of the state widened. Private actors independent of the government made more and more economic decisions based on profit orientation, without concern for macroeconomic growth. Since market reforms restricted the government from allocating resources, the political institutions and leaders were perceived as being weak. The many Koreans who believed the promises that market reforms would benefit all were disappointed. The IMF and the Korean government both argued that the reforms were in the „national interest‟ in the long run, but, due to rising inequality and social insecurity, more people suffered than benefited from these reforms. As the negative social repercussions of the crisis management strategy evolve, the disappointment creates the potential for a serious backlash, not only against market-oriented policies, but also against democratic political institutions in general.31 Economic liberalisation and democratisation have been closely linked in Korea since the introduction of democratisation in 1987 and are viewed as the same by the majority. Surveys conducted in Korea reveal that clear support for democratisation has dramatically declined and the public priority has shifted from democratisation to economic growth.32 In this context, it is interesting that Koreans‟ views on the military dictatorship, and especially the period under the control of Park Chung Hee until 1979, is increasingly romanticised. If the government also loses the legitimacy derived from a widely accepted democratic political process, then even political stability could be at risk. Conclusions The recovery process in Korea since the 1997/98 financial crisis has been relatively successful in achieving macroeconomic recovery, compared to other 11 crisis countries in Southeast Asia and Latin America. Contrary to the „official view‟ presented by the IMF, the macroeconomic recovery in Korea was not the result of the success of market-oriented reforms. On the contrary, the two pillars of recovery were export orientation and massive state intervention and expansion – Korea‟s traditional areas of strength. These traditional strengths Thomas Kalinowski 458 Downloaded By: [2007-2008 Ewha Womans University] At: 06:25 8 December 2008 have been shaped by Korea‟s specific historic development and cannot be easily recreated by other countries. Therefore, the IMF cannot point to Korea as an example of successful structural adjustment policies at work, blaming failures in structural adjustment in other countries as examples of wrong or incomplete implementation of these policies. Korea can be neither an IMF poster child nor a role model for other crisis countries. It was much easier for Korea to overcome the crisis since it had the capacity to externalise costs through exports and increase government spending. The great majority of IMF clients are developing countries that face very different, and less favourable, circumstances. Firstly, these countries‟ exports depend on raw materials and agricultural products, which have less potential for an export-led recovery. Even if competition increases due to currency revaluations, the demand for raw materials and agricultural products does not increase as much as for consumer products, cars and IT equipment. Secondly, governments in developing countries often lack the capacity to finance and create political support for expensive crisis management strategies, which place the burden of the cost of recovery on the whole society. Even Korea will not be able to repeat its own „model‟ of recovery, as the recovery strategy has been undermined by its own success. Managing the successful recovery since 1998 has been the last stage of the strong developmental state. The two engines of Korea‟s recovery, exports and state expansion, have begun to sputter as the traditional Korean developmental strategy faces serious limitations. Firstly, externalising costs of economic growth through exports is getting increasingly difficult. Export orientation works fine if carried out by only a few countries, but ever since the Asian financial crisis and the emergence of China as a major exporter, most developing countries have been implementing this strategy. Consequently, the competition for export markets has increased. Export orientation and current account surpluses depend on markets that are willing and able to accept a current account deficit. Until now, the resulting global imbalance served the interests of both sides, as East Asia was able to enjoy high growth rates and the USA was able to enjoy low import prices and an unlimited inflow of cheap capital from East Asia. However, the gigantic double deficit in the USA is beginning to undermine its role as the consumer of last resort. When the US trade deficit eventually declines, this could lead to serious challenges to East Asia in general, and Korea in particular. Despite a very limited degree of „decoupling‟, economies in East Asia, including Korea, remain dependent on the USA as the consumer of last resort. Until now there have been a few signs that East Asian countries are beginning to give up their obsession with national competitiveness, which focuses on low labour costs and labour flexibility that impede a transformation into a „Fordist regime‟ based on domestic mass consumption and regulated by a comprehensive welfare state. The weakness of the domestic economy and increasing export dependency also led to a further concentration of market power in the hands of a few large chaebol that dominate the Korean export industries. The „traditional strengths‟ 12 helped Korea to recover from the crisis, but at the same time they determine the limits and weaknesses of current Korean development. Secondly, the successful state-led recovery, which combined the socialisation of costs with economic liberalisation, has undermined the fiscal and political capacity of the state in Korea to follow the same costly recovery strategy in potential future crises. Public debts have increased due to the costs of this successful macroeconomic recovery. More importantly, the unequal distribution of benefits and costs of the economic reforms has undermined the political capacity of the government. Many citizens have lost trust in political institutions. They believe that the sacrifices they made were in vain, while only financial investors and a few big chaebol benefited from the economic recovery. This loss of confidence is particularly worrying, since this mistrust of the political elite and their economic policies could lead to a more general scepticism towards democratisation. During the period of the authoritarian developmental state, the government tried to legitimise itself through high economic growth. Through economic liberalisation, the government lost the ability to guarantee high economic growth rates because economic decisions are increasingly made by private actors. At the same time, the government has not been able to generate a new source of legitimacy, as attempts to reinvent the state as a democratic market economy have failed and the transformation into a democratic welfare state has only been tried very cautiously and even reluctantly. The dismantling of the developmental state since the 1980s is a contradictory process that has accelerated since the financial crisis. The Korean state remains in a transformatory limbo and has not found a new role and source of legitimacy. The authoritarian state-centred system has been abolished, but the utopia of the US-style free market democracy favoured by President Kim Dae Jung could not be realised due to contradictions with the economic and social reality. Many of the old proactive elements of developmental states, such as industrial policies and economic planning, have been abolished; however, due to the economically and socially precarious situation of Korea, the government needs to increase the scope and scale of reactive state interventions. Today, government interventions are less proactive and planned, and more reactive and erratic. Frequent market failure makes government intervention inevitable. The unstable financial system is the best example of the need for these interventions, but in many other policy areas, such as social security, support for SMEs, and IT infrastructure, the need for increasing state intervention became obvious as well. There is no theory or vision of the future role of the state in Korea, either in the academic literature or in the political sphere. Initially, most Koreans, and especially the mostly US-trained elite, saw no alternatives to the IMF reforms and economic liberalisation. While the elite remains convinced that any problems resulting from this could be overcome and are a mere „hangover‟ from the „old system‟, scepticism amongst the public about the direction of reforms is growing. There is a lack of vision and political support for an alternative to the utopian US-style market system and the anachronistic state-centred approaches of the past. Unfortunately, Korea has experience neither with a democratically controlled interventionist state nor with a redistributive welfare state. Consequently, the only existing alternative to the failed neoliberal state discussed in Korea is, unfortunately, a conservative one that searches for the key to Korea‟s future in its own past, with an emphasis on authoritarian state intervention, nationalism and a strong political leader. 13 Notes 1. The official IMF position can be found in the Executive Board assessments. For example, the assessment of the IMF Executive Board in the 1999 Article IV Consultations. IMF, „IMF Concludes Article IV Consultation with Korea‟, Public Information Notice (PIN) No. 99/115, http://www.imf.org/external/np/sec/ pn/1999/pn99115.htm (accessed 18 March 2008). The IMF country reports and the large number of staff working papers offer a background analysis of the official view, which highlights the role of market reforms in economic recovery. See for example, IMF Staff, Staff Report for the 2004 Article IV Consultation (Washington DC, 2005), or look at the book edited by former IMF representatives in Seoul: David Coe & Se-Jik Kim (eds), Korean Crisis and Recovery (International Monetary Fund, 2002). 2. Frank Veneroso & Robert Wade, „The Asian Crisis: The High Debt Model Versus the Wall Street-TreasuryIMF Complex‟, New Left Review, No. 228 (1998), pp. 3–20; Robert Wade, „From “Miracle” to “Cronyism”: Explaining the Great Asian Slump‟ (1998); Ha-Joon Chang, J. Gabriel Palma & D. Hugh Whittaker, Financial Liberalization and the Asian Crisis (Palgrave, 2001); Ha-Joon Chang, Hong-Jae Park & Chul Gyue Yoo, „Interpreting the Korean Crisis: Financial Liberalisation, Industrial Policy and Corporate Governance‟, Cambridge Journal of Economics, Vol. 22, No. 6 (1998), pp. 735–46; Seung-Il Jeong, Crisis and Restructuring in East Asia: The Case of the Korean Chaebol and the Automotive Industry (Palgrave Macmillan, 2004). 3. The most important publications on the developmental state in Korea are Alice H. Amsden, Asia‟s Next Giant: South Korea and Late Industrialization (Oxford University Press, 1989); Meredith Woo-Cumings, Race to the Swift: State and Finance in Korean Industrialization (Columbia University Press, 1991); Peter B. Evans, Embedded Autonomy: States and Industrial Transformation (Princeton University Press, 1995); Eun Mee Kim, Big Business, Strong State: Collusion and Conflict in South Korean Development, 1960–1990 (State University of New York Press, 1997); Robert Wade, Governing the Market: Economic Theory and the Role of Government in East Asian Industrialization (Princeton University Press, 2004); Ha-Joon Chang, The East Asian Development Experience: The Miracle, the Crisis and the Future (Zed Books and Third World Network, 2006). 4. World Bank, The East Asian Miracle: Economic Growth and Public Policy (Oxford University Press, 1993). 5. See, for example, Hyun-Chin Lim & Jin-Ho Jang, „Neo-Liberalism in Post-Crisis South Korea: Social Conditions and Outcomes‟, Journal of Contemporary Asia, Vol. 36, No. 4 (2006), pp. 442–63. 6. See, for example, the collection of papers by Ha Joon Chang, The East Asian Development Experience. 7. Linda Weiss, „State Power and the Asian Crisis‟, New Political Economy, Vol. 4, No. 3 (1999), pp. 317–42; Elizabeth Thurbon & Linda Weiss, „Investing in Openness: The Evolution of FDI Strategy in South Korea and Taiwan‟, New Political Economy, Vol. 11, No. 1 (2006), pp. 1–22. 8. Steven Kent Vogel, Japan Remodeled: How Government and Industry Are Reforming Japanese Capitalism (Cornell University Press, 2006). 9. Iain Pirie, „The New Korean State‟, New Political Economy, Vol. 10, No. 1 (2005), pp. 25–42. 10. Theda Skocpol, „Bringing the State Back In: Strategies of Analysis in Current Research‟, in Peter B. Evans, Dietrich Rueschemeyer & Theda Skocpol (eds), Bringing the State Back In (Cambridge University Press, 1985), p. 16. 11. Evans, Embedded Autonomy. 12. Pirie, „The New Korean State‟. 13. Former IMF director Horst Koehler proposed that „the close cooperation between Korea and the IMF over the last few years has been exemplary and in many respects serves as a model for other countries.‟ (IMF, News Brief No. 01/82, 22 August 2001, http://www.imf.org/external/np/sec/nb/2001/nb0182.htm) (accessed 29 September 2008). 14. The reforms that were agreed upon, starting with the first letter of intent dated 3 December 1997, can be accessed at: IMF, Korea country page, http://www.imf.org/external/country/KOR/index.htm (accessed 29 September 2008). 15. See Samsung Economic Research Institute, Three Years after the IMF Bailout, A Review of the Korean Economy‟s Transformation since 1998, Seoul, 2001, p. 22. 16. See, for example, B.: IMF Independent Evaluation Office, The IMF and Recent Capital Account Crisis: Indonesia, Korea, Brazil, Evaluation Report (IMF, 2003). 17. Based on data from the KOSIS database of the Bank of Korea, http://www.bok.or.kr (accessed 30 May 2008). 18. Thurbon & Weiss, „Investing in Openness‟. 19. See Asian Development Bank statistics, http://www.adb.org (accessed 19 November 2007). 20. Korea‟s GINI coefficient increased significantly from 0.283 in 1997 to 0.310 in 2004. This is the third most unequal distribution of income in the OECD, with only Mexico and the USA showing greater disparity. (See Joong Ang Ilbo, 25 February 2005, and National Statistical Service, Annual Report on the Household and Expenditure Survey, Seoul (various years)). 21. Korea Times, 12 March 2003. 22. The Economist, 21 October 2006. 14 23. This statistic excluded investments from Hong Kong and the British Virgin Islands to the PRC. (See Table 2 at The US/China Business Council, http://www.uschina.org/statistics/2005foreigninvestment.html). 24. IMF Staff, „Staff Report for the 2004 Article IV Consultation‟, p. 6. 25. National Statistical Office, KOSIS, http://www.nso.go.kr (accessed 19 November 2007). 26. See OECD, Economic Surveys: Korea (OECD, 2003), p. 52. 27. See IMF, IMF Country Report Korea (IMF, 2003), p. 102. 28. See IMF, Country Report Korea. 29. OECD, „OECD Statistics‟, http://stats.oecd.org (accessed 28 February 2008). 30. Thurbon & Weiss, „Investing in Openness.‟ 31. Thomas Kalinowski, „Democracy, Economic Crisis, and Market Oriented Reforms‟, Comparative Sociology, Vol. 6, No. 3 (2007), pp. 344–73. 32. The share of people who said that „democracy was always preferable‟ dropped from 69 per cent in 1997 to 49 per cent in 2001/02. On the other hand the share of people who said that „authoritarianism is sometimes preferable‟ increased from 20 to 33 per cent in the same period of time. See Asia Barometer Project, Korea Barometer Survey, several years, http://www.koreabarometer.org (accessed 29 September 2008). 15

This article was downloaded by: [2007-2008 Ewha Womans University] On: 8 December 2008 Access details: Access Details: [subscription number 768754898] Publisher Routledge Informa Ltd Registered in England and Wales Registered Number: 1072954 Registered office: Mortimer House, 37-41 Mortimer Street, London W1T 3JH, UK New Political Economy Publication details, including instructions for authors and subscription information: http://www.informaworld.com/smpp/title~content=t713439457 Korea's Recovery since the 1997/98 Financial Crisis: The Last Stage of the Developmental State Thomas Kalinowski a a Graduate School of International Studies, Ewha Womans University, Seoul, Korea Online Publication Date: 01 December 2008 To cite this Article Kalinowski, Thomas(2008)'Korea's Recovery since the 1997/98 Financial Crisis: The Last Stage of the Developmental State',New Political Economy,13:4,447 — 462 To link to this Article: DOI: 10.1080/13563460802436616 URL: http://dx.doi.org/10.1080/13563460802436616 PLEASE SCROLL DOWN FOR ARTICLE Full terms and conditions of use: http://www.informaworld.com/terms-and-conditions-of-access.pdf This article may be used for research, teaching and private study purposes. 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New Political Economy, Vol. 13, No. 4, December 2008 Korea’s Recovery since the 1997/98 Financial Crisis: The Last Stage of the Developmental State Downloaded By: [2007-2008 Ewha Womans University] At: 06:25 8 December 2008 THOMAS KALINOWSKI In this article, I challenge the view that Korea’s successful macroeconomic recovery from the 1997/98 financial crisis was the result of market-oriented reforms and International Monetary Fund (IMF)-prescribed structural adjustments. I show that the recovery was mainly achieved by the ‘traditional strengths’ of the pre-crisis development model, resting on export orientation and strong state capacity, rather than a transformation into a new ‘neoliberal’ state. However, I also show that economic liberalisation and market reforms undermine state capacity and restrict a proactive and developmental role of the state. In short, the successful recovery was the last stage of the developmental state in Korea. The article is organised as follows. In section one, I provide a critical review of the relevant literature on Korean post-crisis restructuring and present my argument in more detail. In section two, I show that the main contributor in stabilising the economy and replenishing foreign currency reserves was Korea’s exports, and not the process of regaining foreign investors’ confidence through market opening and financial liberalisation. In section three, I illustrate the importance of state intervention for the economic recovery of Korea and, in section four, I argue that this state capacity is a product of the Korean developmental state, which has slowly been undermined by market-oriented reforms. I conclude in section five that Korea’s successful recovery has been based on the two pillars of export orientation and state expansion, which face internal and external limitations, making a similar strategy unviable for other countries and even for potential future crises in Korea. Korea since 1997: restructured or remodelled? The IMF, World Bank and the majority of economists praise Korea’s successful recovery from the 1997/98 financial crisis as a result of the strong commitment of the Korean government to depart from previous interventionist government policies and restructure Korea into an open market economy with an efficient regulatory state. In this view, the role of the state is reduced to providing a framework Thomas Kalinowski, Graduate School of International Studies, Ewha Womans University, 11-1 Daehyun-dong, Seodaemun-gu, Seoul, 120-750, Korea. ISSN 1356-3467 print; ISSN 1469-9923 online/08/040447-16 # 2008 Taylor & Francis DOI: 10.1080/13563460802436616 Downloaded By: [2007-2008 Ewha Womans University] At: 06:25 8 December 2008 Thomas Kalinowski for the market and allowing government intervention to take place only in the exceptional case of market failure. This ‘official version’ claims that Korea overcame the crisis because it was able to regain ‘market confidence’, reversing the outflow of foreign capital and luring investors back to Korea.1 This is consistent with the IMF’s analysis of the causes of the crisis, seen as the result of foreign investors losing their confidence in the Korean economy because the Korean model of a strong developmental state had become anachronistic. Too much state intervention in the economy (‘crony capitalism’) was seen to have undermined the functioning of market forces and led to the crisis. Adherents of the developmental state theory criticise this ‘official version’ of events and argue that the dismantling of the developmental state through economic liberalisation is what contributed to the crisis in the first place, by creating a regulatory vacuum that led to the unsustainable inflow of foreign capital.2 I generally agree with the developmental state theory’s view of the economic development of Korea leading up to the crisis.3 Indeed, since the publication of the East Asian Miracle by the World Bank in 1993, the importance of public policy in East Asian development has been widely acknowledged and criticism has been directed not towards the effects of the developmental state in the past, but rather its applicability for the present and future.4 However, the developmental state perspective has limits in explaining the economic recovery since 1998. If the dismantling of the developmental state was responsible for the crisis, how could accelerated market reforms under IMF-sponsored structural adjustment be reconciled with the successful recovery? In fact, many proponents of the developmental state theory dispute that there has been a recovery at all. They claim that despite the average real growth rate of more than 5.5 per cent from 1999 to 2007, social inequality and poverty have increased5 and corporate investments remain much lower than before the crisis.6 However, although it is true that the domestic economy in Korea remains weak and social inequality has increased dramatically, the successful macroeconomic recovery cannot be ignored and deserves explanation. In contrast to the ‘recovery pessimists’ of the developmental state camp, Linda Weiss provides an interpretation for Korea’s successful recovery that is consistent with developmental state theory. Weiss argues that the developmental state is largely still intact and that market reforms were shaped by an active state in a typically ‘Korean way’. Market-oriented reforms remained shallow and merely remodelled the developmental state.7 Steven Vogel uses a very similar argument to account for the slow and idiosyncratic implementation of market reforms in Japan.8 Vogel and Weiss thus highlight the path dependency of East Asian capitalism and reject the hypothesis that different forms of capitalism have been converging on an Anglo-American style of ‘free market capitalism’. Iain Pirie, on the other hand, opposes the path dependency argument and contends that there has been a convergence of capitalisms. He claims that Korea has become a ‘new’ neoliberal state that is very similar to US-style capitalism in its regulatory changes, such as improved shareholder rights and, in particular, the new independent central bank.9 Pirie is correct in claiming that the state acted as midwife to more unfettered markets, but Korea is still far from becoming an economy that is driven by market competition and financial investors. Weiss 448 Downloaded By: [2007-2008 Ewha Womans University] At: 06:25 8 December 2008 Korea’s Recovery since the 1997/98 Financial Crisis correctly argues that many of the changes Pirie describes remain at the regulatory level, and have not transformed the underlying institutions. In this article, I provide further support for the hypotheses of Weiss and the ‘remodelling’ camp which highlight path dependency and the continuous importance of the state. I argue that the two traditional strengths of the Korean development model – export orientation and a strong state – helped the country to recover successfully. I show that market confidence and foreign investors returned to Korea only after massive state intervention and exports had stabilised the economy. It is not surprising that exports played a pivotal role in Korea’s recovery given the traditional strengths of the export sector and the massive devaluation of the Korean currency during the crisis. The export-oriented recovery does not contradict the IMF’s interpretation of the events. Most observers, including the IMF, acknowledge the role of exports, yet overrate the role of the currency devaluation in the export-led recovery and underestimate the role of structural strengths in the export sector. Exports were crucial for the recovery by helping accumulate foreign currency reserves, but this cannot explain the restabilisation of banks and financial markets. Here, the strong state, the second ‘traditional strength’ of the Korean developmental model, allowed the government to intervene directly in the financial markets in order to refinance and restructure the financial sector, as well as to socialise the costs of the crisis, unlike many other developing countries. I adopt Theda Skocpol’s concept of state capacity, where state capacity is based on sovereign integrity, loyal and skilled officials, and financial resources.10 The sovereign integrity of Korea and the loyalty and skills of Korean officials have not been questioned during the crisis and are not of particular concern here. The financial capacity of the state, on the other hand, was pivotal during the crisis when the Korean economy became illiquid in 1997. The initially low public debt level obviously provided the state with the fiscal capacity to cope with the crisis. Expanding upon Skocpol’s definition, I am arguing that the political capacity to deal with the crisis was at least equally important. Political capacity derived from the relatively strong legitimacy of the state in Korea, which can be attributed to the tradition of a strong state in Korea, as well as the process of democratisation since 1987. The developmental state derived ‘embedded autonomy’ due to its authoritarian nature and the weakness of social groups.11 Since the 1980s, this authoritarian autonomy has vanished. First, the large business conglomerates (chaebol) emerged as an independent interest group and stopped following the government’s economic plans. Since 1987 organised labour and the democratic movement have powerfully claimed freedom from authoritarian rule and helped at least partially to balance the overwhelming power of the chaebol. The state lost its authoritarian autonomy during this process of ‘double emancipation’ and in the 1990s the chaebol’s interest dominated the public discourse and government policies. However, labour unions and other civil society organisations prevented a complete capture of the state by the chaebol and during the financial crisis the struggling chaebol lost much of their credibility and dominance. The state regained democratic autonomy, deriving from a ‘class compromise’ and embedded in a balance of power between diverse social interest groups. I generally follow the ‘remodelling’ argument, but also depart from it as I believe that Ha-Joon Chang, Weiss and other scholars from the developmental 449 Downloaded By: [2007-2008 Ewha Womans University] At: 06:25 8 December 2008 Thomas Kalinowski state tradition overestimate the feasibility of future strategic developmental policies. The role of the state in Korea is increasing and the state remains important to facilitate market reforms, but it is very likely that the market-oriented reforms represent the last stage of the developmental state. Industrial policies still play an important role in supporting Korea’s drive into the information technology (IT) sector, as Weiss shows, but state interventions in the late 2000s are very different from what they were during the heyday of the developmental state. State interventions are becoming less and less strategic and more and more reactive, mitigating the economic and social costs of market-oriented reforms. Thus, the state is getting bigger, but at the same time weaker. It is less strategic, and less associated with ‘midwifery’ than with a ‘nursing’ function – feeding the losers of market reforms and cleaning up the mess when markets get out of control. Scholars in the tradition of developmental state theory overrate the potential of the state to sustain strategic interventions in the future. The successful state-led recovery, together with the implemented market reforms, is severely undermining the developmental and crisis-solving potential of the state. As Pirie notes, these undermining processes are institutional because decision-making processes are delegated to independent institutions such as the central bank or subsequently taken over by market actors.12 It is still too early to evaluate these institutional changes and it remains to be seen how the new ‘market-friendly’ institutions will function when they are tested under pressure. Nevertheless, it is clear that any attempt to return to an old-style developmental state has to fail, because it would require getting the chaebol back under the control of the state. This is hardly imaginable, as the largest chaebol took advantage of the market reforms and transformed themselves into formidable global players. A second trend undermining state capacity is already becoming more obvious. The immense costs of the crisis management have undermined the fiscal and political capacity of the government. A dramatically increased government debt and a higher tax rate leave little room for expensive ‘Korean-style’ recoveries in the future. More importantly, the government, and the political class in general, has lost much of its political credibility. Market-oriented reforms have revitalised the economy but many Koreans are now worse off than before the crisis, having switched to less secure ‘irregular’ jobs or precarious self-employment. Notably, many labour unions and non-governmental organisations (NGOs) regret their general support for the restructuring since 1997 and it is unlikely the government would be able to count on such support for restructuring in the future. This tendency of market reforms to undermine state capacity also questions the IMF’s attempts to present Korea as an example of successful structural readjustment.13 If even Korea is not likely to be able to repeat its own successful recovery, it is unlikely that poorer developing countries with less capable states would be able to follow Korea’s example. Recovery through export orientation The core of IMF reforms, in Korea and elsewhere, is to regain ‘market confidence’ by carrying out ‘market-friendly’ reforms.14 These rather vague terms mean that policies should focus on attracting foreign investment by carrying out 450 Downloaded By: [2007-2008 Ewha Womans University] At: 06:25 8 December 2008 Korea’s Recovery since the 1997/98 Financial Crisis investor-friendly reforms. In the IMF’s view, market confidence can be achieved by reducing the barriers for capital to enter crisis countries and increasing the return on invested capital through supply side-oriented reforms. In the case of Korea, the IMF did not even need to apply pressure to the government to liberalise the financial market – the government opened the financial market even faster, and more radically, than the IMF requested. For example, limits on foreign investment in listed companies were first loosened and subsequently completely abolished in May 1998 – seven months ahead of the IMF’s schedule.15 To increase the return on foreign investment, the IMF demanded interest rate hikes and the rationalisation of corporate governance. However, ‘investorfriendly’ policies did not help trigger Korea’s initial recovery from the crisis. Rather, they had the opposite effect, as high interest rates signalled to investors that Korea was in trouble and panic grew even wider. High interest rates also transformed the financial crisis into an economic crisis, as companies went bankrupt or were forced to introduce rationalisation measures, resulting in massive lay-offs and widespread unemployment. The repercussions of interest rate hikes have been widely criticised and thus it is not necessary to repeat this discussion here.16 Rather, the relevant issue is how Korea was able to recover in spite of these initially disastrous results. Investor confidence was finally regained in 1999, but only after strong exports had already boosted Korea’s foreign currency reserves and massive state intervention had stabilised the economy. During the three years of the IMF structural adjustment programme, beginning in December 1997, approximately 95 per cent of the net inflow of foreign currency reserves came from exports, while capital inflow in the form of portfolio and direct investment was insignificant, and even negative in the case of credits.17 Without question, foreign investment has increased and has played a role in the refinancing and restructuring of individual companies, as Elizabeth Thurbon and Linda Weiss point out.18 Whatever the contributions of foreign investment to the long-term development of individual companies might have been, the inflow of foreign capital did not play a major role in the immediate recovery of 1998/99. Since the crisis, Korea has reverted to a state of extreme export dependency, which was characteristic of Korean development until the 1980s. Export dependency, measured as the export share of gross domestic product (GDP), increased from 23 per cent in 1996 to 38 per cent in 1998. Since then, the share of exports has fluctuated between 30 per cent of GDP in 2002 and 37 per cent in 2006.19 This ever-increasing export orientation was triggered by the devaluation of the Korean currency, which made exports more competitive and imports more expensive. However, dramatically increasing exports could not have been achieved without a strong export industry already in place before the crisis. Korea managed to recover because it had a strong and relatively diversified export economy. Most developing countries depend on exporting agricultural products, raw materials or a few labour-intensive manufactured goods. Korean chaebol, on the other hand, managed to acquire an impressive market share in industries such as ship building, cars, semiconductors, electronic appliances and IT. Thus, from 1998 onwards Korea was able to profit from the upswing of the US economy and the ‘new economy’ boom that led to surging demand for many Korean export 451 Downloaded By: [2007-2008 Ewha Womans University] At: 06:25 8 December 2008 Thomas Kalinowski products. Much of the capital that was withdrawn from East Asia during the crisis fuelled the ‘new economy’ bubble around the world. Ironically, the transfer of capital that triggered the crisis also helped to overcome it, at least for IT exporters such as Korea. The recovery since 1998 was not achieved mainly by a transformation into a new market-oriented system, but rather by reverting to strategies of the past. Export orientation has indeed been one of the important engines of Korean development since the 1960s. This gradually changed when the process of democratisation began in 1987 and Korea’s employees demanded their share of the pie. Domestic mass consumption led the economy into a dynamic new phase of development. Korea became recognised as one of the few developing countries that eventually managed to start transforming itself into a domestic mass consumption-driven ‘Fordist regime’. However, this transformation has since been challenged by the crisis of 1997/98 and the subsequent supply side-oriented reforms. The high dependency on exports reveals the weakness of the domestic economy, with low levels of investment and domestic consumption. Domestic investment is limited by the stricter ‘market-based’ lending criteria of banks. Domestic consumption has decreased due to increasing social cleavages and the growing sense of social insecurity amongst the public. Within a decade after the crisis, Korea had evolved from a country that was applauded by the World Bank for achieving ‘growth with equity’ to one of the most socially unequal societies within the Organisation for Economic Cooperation and Development (OECD).20 The weakness of the domestic market from 1998 was only interrupted by a brief recovery in 2001/02 that was fuelled by credit-financed consumption. Since banks had to meet higher standards to provide loans to companies, they focused on lending money to private households by distributing credit cards without any safeguards. By the late 2000s, over 89 million credit cards had been issued in Korea. The government also supported credit card use by providing tax breaks in order to strengthen domestic consumption. The combination of risky government and management decisions with a consumption mania led many lowincome households directly into insolvency. Currently, there are 4 million Koreans on the ‘black list’ of credit card companies.21 The high level of credit card delinquency triggered a crisis in the credit card industry. In 2003/04 the biggest credit card company, LG-Card, went bankrupt and had to be bailed out by the stateowned Korea Development Bank. It is highly unlikely that the domestic market in Korea would be able to function as an engine for Korean economic development in the near future. Increasing private domestic demand would require higher wages or more redistribution and social security spending. Given the weakness of Korean labour unions, wage increases for the majority of employees are not realistic, other than for regular employees of certain large companies. There is a lack of political forces aiming for or even envisioning such a major transformation away from export orientation and towards a more balanced economy. The problem of export-led recovery and development is that it is not sustainable for a longer period, because export surpluses create deficits in other regions. Since the 1990s, the US current account deficit has absorbed surpluses in East Asia – a trend that cannot continue indefinitely. Trade surpluses usually lead to 452 Downloaded By: [2007-2008 Ewha Womans University] At: 06:25 8 December 2008 Korea’s Recovery since the 1997/98 Financial Crisis an appreciation of the currency of the surplus country and thus undermine international competitiveness. Indeed, the Korean central bank had to intervene constantly in order to prevent the Korean currency from appreciating. As a result, Korean currency reserves are surging and surpassed $260 billion in 2008. In effect, this form of state intervention has helped finance the US current account and government deficit as currency reserves are mostly held in US treasury bonds. At the same time, the accumulation of currency reserves is a form of state subsidy to the Korean export sector as it keeps the Korean currency competitive and indirectly helps finance the consumption of Korean products in the USA. The two most important export markets for Korea are the People’s Republic of China and the USA. The USA is the second biggest market for Korean products, but its status as such has become a major source of uncertainty due to the enormous US trade deficit of over $800 billion. It is difficult to estimate when and how this deficit will decrease, but inevitably it must. The weakening of the US dollar against the Korean currency since 2005 has been making Korean imports more expensive in the USA and has reduced the price of US exports. The subprime mortgage crisis and a possible recession in the USA have also reduced the chances of increasing exports. At the same time, rising oil and commodity prices have increased the price of Korean imports. When all these factors are taken into account, it is obvious that export-led growth has become less and less feasible, and it is no surprise that the Korean current account swung into a deficit in early 2008. Proponents of the ‘decoupling’ hypothesis predict a resilience of East Asian economies amidst a US slowdown.22 They argue that China has become more important as an export market than the USA, but this is only partly true. Many products formerly exported directly to the USA are now simply assembled in China from Korean-made parts and then exported to the USA. Similarly to Korea, China’s growth has been based not on domestic consumption but on exports that depend heavily on the USA as the ‘consumer of last resort’. Thus, the decoupling theory is not convincing and it is likely that East Asia will experience major challenges from a reduction of the trade deficit and an economic slowdown in the USA. In the last decade, the economic rise of China has provided Korea with new export opportunities, but the Chinese economy remains fragile and growth rates will eventually decline. Even more dangerous could be the bursting of the bubble that is growing in the Chinese economy due to excessive speculative capital inflows betting on an appreciation of the currency. Until now, Korea has profited from China’s rapid economic growth and its growing demand for Korean products, but in the future China is likely to become a serious competitor, taking away market share from Korean companies. Korean imports from China will increase, narrowing Korea’s current account surplus towards China. In this context, it is also important to note that Korea became the biggest foreign investor in China in 2004, which indicates massive outsourcing from Korean companies and will result in increasing (re-)imports from China.23 So far, the decoupling theory has no solid empirical foundation, but it has some plausibility for the short-term outlook. Oil and commodity exporters profit from a surge in prices of their products and Korea’s diversified export industries are in 453 Downloaded By: [2007-2008 Ewha Womans University] At: 06:25 8 December 2008 Thomas Kalinowski good position to satisfy the increasing demand in the consumer, transportation and construction sectors. However, to a large extent, the boom in oil and commodity prices are fuelled by a speculative bubble, created by frantic investors seeking new investment opportunities amidst slowing economies in more advanced countries. It is doubtful that commodity exporters will be a reliable export market for Korean products. The only remaining plausible substitute for the USA as the consumer of last resort is the European Union (EU). So far, Korean companies have been weak in penetrating the European market and it remains to be seen if the EU will accept trade deficits comparable to the ones experienced in the USA. The main engine of the Korean economy is thus sputtering as the current account surplus is vanishing. However, contrary to the IMF’s observation that Korea has been ‘flying on one engine’,24 the expansion of government activities has kept the country from crashing. State-led, not market-led recovery As noted earlier, the IMF and the ‘official version’ of recovery and reforms in Korea is that they were led by the market and differ radically from the pre-crisis state-led development. IMF structural adjustments strongly support economic liberalisation, deregulation and ‘market-driven reforms’. In this view, state interventions are only justified in reaction to market failure or are considered to be an undesirable ‘hangover’ from the period of state-led development. I challenge this ‘official view’ and maintain that, in the case of Korea, IMF reforms have been deeply interwoven with the overall increasing role of the state, although the trend is contradictory as the state withdraws in some fields and expands in others. The old-style developmental state in Korea is dead, but this does not mean that the role of the state is declining. On the contrary, it is increasing in size although aims and content of policies are changing. The old developmental state was concerned with economic growth and developing an industry structure, while the new remodelled state is concerned with creating a framework to externalise costs from the economy in order to ensure profitable investments in the private sector. While the active planning of development declines, the role of the state shifts into a reactive cleaning up of the negative effects of crisis and reform in order to make Korea attractive for international investors and tame social discontent. In this process, the size of the state has increased. General public spending grew from 28.8 per cent of GDP in 1997 to 32.6 per cent in 2000 and 35.6 per cent in 2003. The tax burden increased from 19.5 per cent of GDP in 1997 to 21.8 per cent in 2000 and 22.8 per cent in 2003. Government debts increased from 7.5 per cent of GDP in 1997, to 16.3 in 2000 and 18.7 in 2003.25 If government-guaranteed debts are included, the figure is even higher at 42 per cent of the GDP in 2001, up from 16 per cent in 1997.26 While these figures are still relatively low compared to other OECD countries, the surge of government debts in such a short period is remarkable. The interaction between economic liberalisation, privatisation and state intervention can be observed best in the financial market reforms in Korea. Major parts of the financial systems were nationalised during the crisis and there were frequent government bailouts. It is a paradox that, although the IMF promotes 454 Downloaded By: [2007-2008 Ewha Womans University] At: 06:25 8 December 2008 Korea’s Recovery since the 1997/98 Financial Crisis privatisation and market-driven reforms, at the end of the structural adjustment programme in 2000 around 54 per cent of banking capital was controlled by the state, up from 33 per cent before the crisis.27 While the IMF and the government systematically opposed bailouts and tried to limit direct state intervention in the economy, the economic situation made massive state intervention inevitable to prevent another crisis and make financial institutions attractive for foreign investors. Since 1998, the financial market in Korea has appeared to suffer from ‘permanent market failure’, necessitating frequent government interventions. The banking crisis in 1998 was followed by the bond market crisis in 1999, the stock market crisis in 2000 and finally the credit card company crisis in 2003/04. It is still not clear if the US mortgage crisis that emerged in 2007/08 will spread to Korea, but, given the massive housing price bubble and the high level of mortgage debts, it is unlikely that the financial sector will be completely spared. The recovery was based on socialising debts and a shift of responsibility from private investors to the tax payer in order to regain systemic stability. From 1997 to 2001, the government invested more than 150 trillion Won (at that time around US$135 billion) to stabilise the financial market by socialising private debts. This amount is equivalent to 32 per cent of Korean GDP. If the ‘recycled money’ that has been earned by privatisation since then is taken into account, the costs remain at 22 per cent of GDP, which still makes the financial clean-up in Korea one of the most expensive in recent history.28 There are more examples illustrating the complex relationship between economic liberalisation and state intervention, such as in the labour market and social security. To help rationalising businesses, the government liberalised labour laws and lay-offs of workers were made easier in order to increase labour market flexibility for employers. To compensate employees for growing insecurity, the government promised to liberalise regulations regarding labour unions and to strengthen the social security system. In practice, most large-scale strikes in Korea since 1998 have been declared ‘illegal’ by the government and often dissolved by the police. Arrests of labour unionists for organising labour protests even increased during Kim Dae Jung’s presidency (1998– 2003), although he was touted as a pro-labour candidate. The government constantly intervened in labour struggles on the side of employers and at the same time attempted to mitigate the social costs of economic reforms by improving the social security system. As a result, welfare spending increased substantially, from 3.6 per cent of GDP in 1996 to 5.7 per cent in 2003, although this is still far less than in any other OECD country.29 By building up a welfare state, the government explored a completely new field for increasing government intervention and spending. The government not only mitigated the negative social effects of market reforms but also their negative economic effects. Market liberalisation led to an even greater concentration of market power in the hands of a few large chaebol. They were allowed to enter markets that were previously the exclusive domain of small and medium-sized enterprises (SMEs) and gained nearly unlimited access to international financial markets. SMEs, on the other hand, face increasing competition from the chaebol and foreign competitors, while banks are reluctant to provide risky credits to SMEs. Instead of protecting SMEs from the chaebol and 455 Downloaded By: [2007-2008 Ewha Womans University] At: 06:25 8 December 2008 Thomas Kalinowski ordering banks to provide loans to them (‘policy loans’), the government is now forced to support SMEs by subsidies, credit guarantees and investments in infrastructure. The IT industry profited particularly from this direct government engagement.30 Another example of the interaction between liberalisation and state intervention is in exchange rate policy. When Korea’s central bank became independent and fixed exchange rates were abolished after the crisis, Korea switched to a system of managed floating. Interventions in the exchange market have become increasingly important to improve international competitiveness. The Korean central bank is building up reserves, which reached $239 billion at the end of 2006. Korea now ranks fifth in reserves, just after China, Japan, Taiwan and Russia. These reserves protect Korea from another foreign exchange crisis as in 1997/ 98 and prevent the Korean currency from appreciating against the US dollar. Thus, Korean exports remain competitive and stabilise the economy. However, since the end of 2004, this trend has reversed and the Korean currency has appreciated, substantially harming exports. Economic liberalisation went hand in hand with massive state intervention and expansion. In some areas the role of the state decreased, while it increased in other areas. The currency peg was abolished and the regulation of foreign capital inflow was liberalised, but interventions into currency markets by the central banks have increased. Government protection of employment is weakened, but welfare spending increased substantially. In the field of industrial policies, the government stopped directly ordering banks to finance certain sectors of the economy. On the other hand, the government now provides credit guarantees and direct subsidies for sectors such as IT. In the past, development was financed by government-directed policy loans, whereas now it is supported by direct government subsidies and guarantees. Why was Korea able to achieve a state-led recovery? An active and expansionary state was crucial for economic recovery. But why was Korea able to achieve this state-led recovery when many other governments in similar crises failed? At least two features of the Korean state were pivotal in providing the capacity to manage the crisis. First, Korea had the fiscal capacity to socialise the costs of the crisis. As we saw earlier, the initial debt level in Korea was very low. Thus, the government was able to use vast amounts of public funding to stabilise the financial system and expand government spending in general. Secondly, the government in Korea, at least initially, held the trust of its citizens and thus had the political capacity to manage the crisis. While painful economic restructuring created political chaos in crisis countries such as Indonesia (in 1997/98) and Argentina (in 1999 – 2001), protests in Korea never threatened the stability of the government. The government was able to place the burden of the costs of adjustment on the public without facing massive opposition because Koreans were willing to make sacrifices in order to achieve national recovery. Economic recovery became the ‘national goal’ and the government took advantage of this strengthening nationalism, caused by the crisis situation. Confidence 456 Downloaded By: [2007-2008 Ewha Womans University] At: 06:25 8 December 2008 Korea’s Recovery since the 1997/98 Financial Crisis in the government to manage the crisis was stronger in Korea compared to other crisis countries. This can be seen, for example, from the differing reactions to the bank deposit guarantees announced by the government. Directly after the outbreak of the financial crisis across Asia in 1997, the governments of all affected countries guaranteed bank deposits in order to avoid a run on the banks. However, Thai and Indonesian savers still rushed to secure their savings and exchange them into dollars. Similar behaviour occurred later in the Argentine crisis. In contrast, most Korean savers did not withdraw their money from banks, because they trusted the state guarantees. Many Koreans even brought their own reserves, such as gold and dollars, to the banks in order to ‘save the national economy’. Two factors can explain the initial trust of Korean citizens in their government to manage the crisis in a competent and just way: the experience of a successful developmental state until the 1980s, and the process of democratisation since the 1980s. Firstly, in contrast to Latin American countries, Koreans experienced a long history of successful government-planned economic development from the 1960s until the 1980s. This experience created trust in the capability of the government to manage the economy, even during challenging times. Most citizens perceived structural adjustments and market-oriented reforms merely as a new government strategy to achieve economic growth and higher living standards, just like the five-year plans for industrialisation during the military dictatorship. The experience with a successful developmental state created legitimacy in guaranteeing high economic growth rates that benefited the large majority of people. Even after two decades of economic liberalisation, the expectations that the government would manage the economy in the ‘national interest’ remained strong. Secondly, democratisation since the 1980s provided Koreans with the power to elect a new government. Koreans elected a new president just two weeks after the outbreak of the crisis. Incoming President Kim Dae Jung gave the recovery strategy a legitimacy that the old Kim Young Sam government (1993– 98) was not able to provide, because it was largely held responsible for the crisis. The fresh start allowed by democratic elections was in stark contrast to crisis countries such as Indonesia, where the dictator Suharto failed to generate support for his crisis management strategy and was overthrown by mass protests in 1998. Through democracy, Koreans felt responsible for their own country, liberating themselves from the military oppression in the 1980s. Democratic elections provided the government with unprecedented legitimacy and created a remarkable political stability. President Kim Dae Jung and his successor Roh Moo Hyun both served the full five years of their terms, even though they did not have a majority in parliament during most of their tenure and were frequently forced to reshuffle their cabinet members. Argentina, in contrast, had five different presidents during the economic crisis from 1999 to 2001. Regardless of whether market reform policies in Korea during the IMF era are evaluated as successful or not, the fundamental changes have not politically destabilised the country. This distinguishes the Korean development from 1997 from many other structural adjustment processes in other crisis countries. The Kim Dae Jung government tried to generate new confidence in state capacity by substituting the fading allocation capacity of the developmental state with a redistributing welfare state, as we have seen above. Unfortunately, 457 Downloaded By: [2007-2008 Ewha Womans University] At: 06:25 8 December 2008 Thomas Kalinowski the improvements of the welfare state were hesitant at best, and the government failed to present the welfare state as an alternative vision for Korea. Welfare contributions were perceived as an increasing tax burden, while the services offered by the welfare system were either accessible only to the very poor or remained very limited. The national health insurance system, for example, offered a universal health insurance, but co-payments were very high. Whereas political stability and capacity were initially high, there is much evidence that the state capacity was undermined by the market-oriented reforms. The diminished state capacity reached an extent where future ‘Korean-style’ recoveries have become unfeasible. Firstly, the fiscal capacity to mitigate the costs of potential future crises has deteriorated, as we have seen above. Secondly, the political capacity of the government to create political support for its crisis management strategy has also been undermined. The experience of a successful developmental state and the process of democratisation provided the government with the trust of the people to manage the crisis. However, market-oriented reforms undermined the actual capacity of the state to guarantee high growth rates and the gap between the expectations of citizens and the actual capacity of the state widened. Private actors independent of the government made more and more economic decisions based on profit orientation, without concern for macroeconomic growth. Since market reforms restricted the government from allocating resources, the political institutions and leaders were perceived as being weak. The many Koreans who believed the promises that market reforms would benefit all were disappointed. The IMF and the Korean government both argued that the reforms were in the ‘national interest’ in the long run, but, due to rising inequality and social insecurity, more people suffered than benefited from these reforms. As the negative social repercussions of the crisis management strategy evolve, the disappointment creates the potential for a serious backlash, not only against market-oriented policies, but also against democratic political institutions in general.31 Economic liberalisation and democratisation have been closely linked in Korea since the introduction of democratisation in 1987 and are viewed as the same by the majority. Surveys conducted in Korea reveal that clear support for democratisation has dramatically declined and the public priority has shifted from democratisation to economic growth.32 In this context, it is interesting that Koreans’ views on the military dictatorship, and especially the period under the control of Park Chung Hee until 1979, is increasingly romanticised. If the government also loses the legitimacy derived from a widely accepted democratic political process, then even political stability could be at risk. Conclusions The recovery process in Korea since the 1997/98 financial crisis has been relatively successful in achieving macroeconomic recovery, compared to other crisis countries in Southeast Asia and Latin America. Contrary to the ‘official view’ presented by the IMF, the macroeconomic recovery in Korea was not the result of the success of market-oriented reforms. On the contrary, the two pillars of recovery were export orientation and massive state intervention and expansion – Korea’s traditional areas of strength. These traditional strengths 458 Downloaded By: [2007-2008 Ewha Womans University] At: 06:25 8 December 2008 Korea’s Recovery since the 1997/98 Financial Crisis have been shaped by Korea’s specific historic development and cannot be easily recreated by other countries. Therefore, the IMF cannot point to Korea as an example of successful structural adjustment policies at work, blaming failures in structural adjustment in other countries as examples of wrong or incomplete implementation of these policies. Korea can be neither an IMF poster child nor a role model for other crisis countries. It was much easier for Korea to overcome the crisis since it had the capacity to externalise costs through exports and increase government spending. The great majority of IMF clients are developing countries that face very different, and less favourable, circumstances. Firstly, these countries’ exports depend on raw materials and agricultural products, which have less potential for an export-led recovery. Even if competition increases due to currency revaluations, the demand for raw materials and agricultural products does not increase as much as for consumer products, cars and IT equipment. Secondly, governments in developing countries often lack the capacity to finance and create political support for expensive crisis management strategies, which place the burden of the cost of recovery on the whole society. Even Korea will not be able to repeat its own ‘model’ of recovery, as the recovery strategy has been undermined by its own success. Managing the successful recovery since 1998 has been the last stage of the strong developmental state. The two engines of Korea’s recovery, exports and state expansion, have begun to sputter as the traditional Korean developmental strategy faces serious limitations. Firstly, externalising costs of economic growth through exports is getting increasingly difficult. Export orientation works fine if carried out by only a few countries, but ever since the Asian financial crisis and the emergence of China as a major exporter, most developing countries have been implementing this strategy. Consequently, the competition for export markets has increased. Export orientation and current account surpluses depend on markets that are willing and able to accept a current account deficit. Until now, the resulting global imbalance served the interests of both sides, as East Asia was able to enjoy high growth rates and the USA was able to enjoy low import prices and an unlimited inflow of cheap capital from East Asia. However, the gigantic double deficit in the USA is beginning to undermine its role as the consumer of last resort. When the US trade deficit eventually declines, this could lead to serious challenges to East Asia in general, and Korea in particular. Despite a very limited degree of ‘decoupling’, economies in East Asia, including Korea, remain dependent on the USA as the consumer of last resort. Until now there have been a few signs that East Asian countries are beginning to give up their obsession with national competitiveness, which focuses on low labour costs and labour flexibility that impede a transformation into a ‘Fordist regime’ based on domestic mass consumption and regulated by a comprehensive welfare state. The weakness of the domestic economy and increasing export dependency also led to a further concentration of market power in the hands of a few large chaebol that dominate the Korean export industries. The ‘traditional strengths’ helped Korea to recover from the crisis, but at the same time they determine the limits and weaknesses of current Korean development. Secondly, the successful state-led recovery, which combined the socialisation of costs with economic liberalisation, has undermined the fiscal and political 459 Downloaded By: [2007-2008 Ewha Womans University] At: 06:25 8 December 2008 Thomas Kalinowski capacity of the state in Korea to follow the same costly recovery strategy in potential future crises. Public debts have increased due to the costs of this successful macroeconomic recovery. More importantly, the unequal distribution of benefits and costs of the economic reforms has undermined the political capacity of the government. Many citizens have lost trust in political institutions. They believe that the sacrifices they made were in vain, while only financial investors and a few big chaebol benefited from the economic recovery. This loss of confidence is particularly worrying, since this mistrust of the political elite and their economic policies could lead to a more general scepticism towards democratisation. During the period of the authoritarian developmental state, the government tried to legitimise itself through high economic growth. Through economic liberalisation, the government lost the ability to guarantee high economic growth rates because economic decisions are increasingly made by private actors. At the same time, the government has not been able to generate a new source of legitimacy, as attempts to reinvent the state as a democratic market economy have failed and the transformation into a democratic welfare state has only been tried very cautiously and even reluctantly. The dismantling of the developmental state since the 1980s is a contradictory process that has accelerated since the financial crisis. The Korean state remains in a transformatory limbo and has not found a new role and source of legitimacy. The authoritarian state-centred system has been abolished, but the utopia of the US-style free market democracy favoured by President Kim Dae Jung could not be realised due to contradictions with the economic and social reality. Many of the old proactive elements of developmental states, such as industrial policies and economic planning, have been abolished; however, due to the economically and socially precarious situation of Korea, the government needs to increase the scope and scale of reactive state interventions. Today, government interventions are less proactive and planned, and more reactive and erratic. Frequent market failure makes government intervention inevitable. The unstable financial system is the best example of the need for these interventions, but in many other policy areas, such as social security, support for SMEs, and IT infrastructure, the need for increasing state intervention became obvious as well. There is no theory or vision of the future role of the state in Korea, either in the academic literature or in the political sphere. Initially, most Koreans, and especially the mostly US-trained elite, saw no alternatives to the IMF reforms and economic liberalisation. While the elite remains convinced that any problems resulting from this could be overcome and are a mere ‘hangover’ from the ‘old system’, scepticism amongst the public about the direction of reforms is growing. There is a lack of vision and political support for an alternative to the utopian US-style market system and the anachronistic state-centred approaches of the past. Unfortunately, Korea has experience neither with a democratically controlled interventionist state nor with a redistributive welfare state. Consequently, the only existing alternative to the failed neoliberal state discussed in Korea is, unfortunately, a conservative one that searches for the key to Korea’s future in its own past, with an emphasis on authoritarian state intervention, nationalism and a strong political leader. 460 Korea’s Recovery since the 1997/98 Financial Crisis Downloaded By: [2007-2008 Ewha Womans University] At: 06:25 8 December 2008 Notes 1. The official IMF position can be found in the Executive Board assessments. For example, the assessment of the IMF Executive Board in the 1999 Article IV Consultations. IMF, ‘IMF Concludes Article IV Consultation with Korea’, Public Information Notice (PIN) No. 99/115, http://www.imf.org/external/np/sec/ pn/1999/pn99115.htm (accessed 18 March 2008). The IMF country reports and the large number of staff working papers offer a background analysis of the official view, which highlights the role of market reforms in economic recovery. See for example, IMF Staff, Staff Report for the 2004 Article IV Consultation (Washington DC, 2005), or look at the book edited by former IMF representatives in Seoul: David Coe & Se-Jik Kim (eds), Korean Crisis and Recovery (International Monetary Fund, 2002). 2. Frank Veneroso & Robert Wade, ‘The Asian Crisis: The High Debt Model Versus the Wall Street-TreasuryIMF Complex’, New Left Review, No. 228 (1998), pp. 3–20; Robert Wade, ‘From “Miracle” to “Cronyism”: Explaining the Great Asian Slump’ (1998); Ha-Joon Chang, J. Gabriel Palma & D. Hugh Whittaker, Financial Liberalization and the Asian Crisis (Palgrave, 2001); Ha-Joon Chang, Hong-Jae Park & Chul Gyue Yoo, ‘Interpreting the Korean Crisis: Financial Liberalisation, Industrial Policy and Corporate Governance’, Cambridge Journal of Economics, Vol. 22, No. 6 (1998), pp. 735–46; Seung-Il Jeong, Crisis and Restructuring in East Asia: The Case of the Korean Chaebol and the Automotive Industry (Palgrave Macmillan, 2004). 3. The most important publications on the developmental state in Korea are Alice H. Amsden, Asia’s Next Giant: South Korea and Late Industrialization (Oxford University Press, 1989); Meredith Woo-Cumings, Race to the Swift: State and Finance in Korean Industrialization (Columbia University Press, 1991); Peter B. Evans, Embedded Autonomy: States and Industrial Transformation (Princeton University Press, 1995); Eun Mee Kim, Big Business, Strong State: Collusion and Conflict in South Korean Development, 1960–1990 (State University of New York Press, 1997); Robert Wade, Governing the Market: Economic Theory and the Role of Government in East Asian Industrialization (Princeton University Press, 2004); Ha-Joon Chang, The East Asian Development Experience: The Miracle, the Crisis and the Future (Zed Books and Third World Network, 2006). 4. World Bank, The East Asian Miracle: Economic Growth and Public Policy (Oxford University Press, 1993). 5. See, for example, Hyun-Chin Lim & Jin-Ho Jang, ‘Neo-Liberalism in Post-Crisis South Korea: Social Conditions and Outcomes’, Journal of Contemporary Asia, Vol. 36, No. 4 (2006), pp. 442 –63. 6. See, for example, the collection of papers by Ha Joon Chang, The East Asian Development Experience. 7. Linda Weiss, ‘State Power and the Asian Crisis’, New Political Economy, Vol. 4, No. 3 (1999), pp. 317 –42; Elizabeth Thurbon & Linda Weiss, ‘Investing in Openness: The Evolution of FDI Strategy in South Korea and Taiwan’, New Political Economy, Vol. 11, No. 1 (2006), pp. 1 –22. 8. Steven Kent Vogel, Japan Remodeled: How Government and Industry Are Reforming Japanese Capitalism (Cornell University Press, 2006). 9. Iain Pirie, ‘The New Korean State’, New Political Economy, Vol. 10, No. 1 (2005), pp. 25–42. 10. Theda Skocpol, ‘Bringing the State Back In: Strategies of Analysis in Current Research’, in Peter B. Evans, Dietrich Rueschemeyer & Theda Skocpol (eds), Bringing the State Back In (Cambridge University Press, 1985), p. 16. 11. Evans, Embedded Autonomy. 12. Pirie, ‘The New Korean State’. 13. Former IMF director Horst Koehler proposed that ‘the close cooperation between Korea and the IMF over the last few years has been exemplary and in many respects serves as a model for other countries.’ (IMF, News Brief No. 01/82, 22 August 2001, http://www.imf.org/external/np/sec/nb/2001/nb0182.htm) (accessed 29 September 2008). 14. The reforms that were agreed upon, starting with the first letter of intent dated 3 December 1997, can be accessed at: IMF, Korea country page, http://www.imf.org/external/country/KOR/index.htm (accessed 29 September 2008). 15. See Samsung Economic Research Institute, Three Years after the IMF Bailout, A Review of the Korean Economy’s Transformation since 1998, Seoul, 2001, p. 22. 16. See, for example, B.: IMF Independent Evaluation Office, The IMF and Recent Capital Account Crisis: Indonesia, Korea, Brazil, Evaluation Report (IMF, 2003). 17. Based on data from the KOSIS database of the Bank of Korea, http://www.bok.or.kr (accessed 30 May 2008). 18. Thurbon & Weiss, ‘Investing in Openness’. 19. See Asian Development Bank statistics, http://www.adb.org (accessed 19 November 2007). 461 Downloaded By: [2007-2008 Ewha Womans University] At: 06:25 8 December 2008 Thomas Kalinowski 20. Korea’s GINI coefficient increased significantly from 0.283 in 1997 to 0.310 in 2004. This is the third most unequal distribution of income in the OECD, with only Mexico and the USA showing greater disparity. (See Joong Ang Ilbo, 25 February 2005, and National Statistical Service, Annual Report on the Household and Expenditure Survey, Seoul (various years)). 21. Korea Times, 12 March 2003. 22. The Economist, 21 October 2006. 23. This statistic excluded investments from Hong Kong and the British Virgin Islands to the PRC. (See Table 2 at The US/China Business Council, http://www.uschina.org/statistics/2005foreigninvestment.html). 24. IMF Staff, ‘Staff Report for the 2004 Article IV Consultation’, p. 6. 25. National Statistical Office, KOSIS, http://www.nso.go.kr (accessed 19 November 2007). 26. See OECD, Economic Surveys: Korea (OECD, 2003), p. 52. 27. See IMF, IMF Country Report Korea (IMF, 2003), p. 102. 28. See IMF, Country Report Korea. 29. OECD, ‘OECD Statistics’, http://stats.oecd.org (accessed 28 February 2008). 30. Thurbon & Weiss, ‘Investing in Openness.’ 31. Thomas Kalinowski, ‘Democracy, Economic Crisis, and Market Oriented Reforms’, Comparative Sociology, Vol. 6, No. 3 (2007), pp. 344–73. 32. The share of people who said that ‘democracy was always preferable’ dropped from 69 per cent in 1997 to 49 per cent in 2001/02. On the other hand the share of people who said that ‘authoritarianism is sometimes preferable’ increased from 20 to 33 per cent in the same period of time. See Asia Barometer Project, Korea Barometer Survey, several years, http://www.koreabarometer.org (accessed 29 September 2008). 462