South Korea's Economic Prospects
CRS Report for Congress
South Korea’s Economic Prospects
Raymond J. Ahearn
Specialist in Trade Relations
Foreign Affairs and National Defense
As South Korea has completed a full year of restructuring under an International
Monetary Fund (IMF) imposed program, the prospects for a sustained economic
recovery are mixed. While the financial crisis that broke out in October 1997 has been
alleviated, the contraction of South Korea’s economy intensified in 1998. A significant
drop in Gross National Product, as well as a rapid increase in unemployment, has
precipitated Seoul’s most serious economic and social crisis since the end of the Korean
War. To return the economy to a healthy growth trajectory, the government is
attempting to reform the financial and corporate sectors, as well as to create more
flexibility in labor markets. Analysts now predict that the South Korean economy might
resume growth in the last quarter of 1999. South Korea’s economic crisis, in turn, is
having both short and long term consequences for U.S. economic interests. Short term,
the United States is experiencing a rising trade deficit with South Korea, as well as
increased conflict on a number of sectoral trade issues. Longer term, however, the
reforms that Seoul is implementing have the potential to make it a much more open,
important, and stable trade partner. This report will be updated periodically. A related
CRS report is Korea: U.S.-South Korean Relations--Issues for Congress, CRS Issue
By the close of 1997, South Korea was in the midst of a serious financial crisis. Due
in large part to a sharp increase in repayments required on short-term external debt, the
country’s foreign currency reserves dropped precipitously to a precariously low $4 billion
level. This undermined investor confidence and capital fled the country. The Korean won
lost half its value, going from 800 won to 1,600 won to the dollar, within a few days. At
the same time, some major industrial conglomerates (chaebol) declared bankruptcy, and
the value of the Korean stock market plummeted. To deal with the crisis, the government
agreed in late December 1997 to the terms of a $57 billion support package put together
Sources of information include various reports of the International Monetary Fund, the1
Korean Economic Institute of America, and the Economist Intelligence Unit Country Reports.
Congressional Research Service ˜ The Library of Congress
by the International Monetary Fund (IMF), and engaged in a U.S.-backed negotiation on
debt-payment moratorium and rescheduling. 2
As a quid pro quo for the IMF emergency loans, South Korea agreed to pursue tight
monetary and fiscal policies, to refinance and restructure the banking system through
direct government assistance, and to enact wider policy reforms aimed primarily at making
large conglomerates and labor markets more efficient. Buttressed by laws passed in early
1998 to toughen financial oversight and agreement by international banks to reschedule
foreign debts, Korea’s financial crisis began to stabilize. By year-end 1998, Korea was
experiencing major improvements in its financial position with foreign exchange reserves
approaching $50 billion and with an annualized current account surplus of about $40
billion. In January 1999, Korea began paying back its IMF loan, and international credit
agencies began upgrading its sovereign risk rating from junk bond to investment grade
Despite the improvement in Korea’s financial position, its real economy continues
to suffer. The overall economy contracted by 6% and unemployment rose to about 8% in
1998. No growth is predicted until the last quarter of 1999, and unemployment is
expected to continue to rise as thousands of small and medium sized companies go
bankrupt every month. Behind these numbers are painful adjustments for millions of
ordinary Koreans, particularly in terms of job losses and a dramatic decline in living
Restoring Economic Growth
Restoration of economic growth depends on both improvements in the global
economy and implementation of internal reforms. Improvements in the health of the
global economy, particularly the Asian economy, would do much to boost Korean growth.
Nearly 50% of Korean exports now go to Asia, and the export sector has been hard hit by
economic declines there.
While South Korea has limited influence on improving the global economy, it can
work to restore its own economic growth by enacting structural reforms more vigorously.
According to a number of analysts, the fundamental cause of Korea’s economic plight is
that capital and labor productivity in most industries are less than 50% of levels in the
United States and Japan. Low capital productivity resulted from a banking system that
provided the chaebol with easy credit for basically undisciplined capacity expansion in a
growing number of industries. Not needing to worry about profitability, the top chaebol
created considerable overcapacity in industries such as cars, petrochemicals,
semiconductors, and steel. At the same time, under political pressure to avoid labor
troubles, the chaebol over the past decade awarded labor a five-fold increase in wages that
was not matched by increases in productivity.
For background, see Nanto, Dick K. and Vivian C. Jones, “South Korea’s Economy and2
WuDunn, Sheryl. “South Korea’s Mood Swings From Bleak to Bullish,” New York Times,3
January 24, 1999, p. A 3.
The IMF program provides external pressure to assure that productivity-enhancing
reforms of the banking, corporate, and labor sectors take place. While some critics have
argued that Seoul has not moved fast enough, the government has maintained that much
is being done, particularly given the wider economic and social repercussions that have to
be considered in the implementation process. All agree, however, that the domestic
reforms are indispensable for economic recovery.
Banking Reforms. A key component of Korea’s reform program is a comprehensive
restructuring and recapitalization of the banking system. Korea’s banks are burdened by
a high level of non-performing loans and an eroded capital base. One estimate is that 20%
of all bank loans are to some extent non-performing and that half of those will have to be
The first step the government took to deal with this problem early in 1998 was to
establish an independent, financial supervisory institution called the Financial Supervisory
Commission. Next a total of 94 financial institutions, including 16 merchant banks, two
securities firms, and one investment trust, were closed. Remaining banks have been
ordered to clean up the number of non-performing loans to meet international capital
adequacy standards. The government has also announced, and partially funded, a 64
trillion won ($54 billion) fund to purchase non-performing loans and to fund bank4
The government has decided to deal with the six biggest and most troubled banks
through mergers or sales to foreign investors. The hope is that “super” banks will have
enough leverage over the chaebol to begin allocating credit efficiently. In return for an
infusion of new capital into the troubled banks, the government is demanding cost
reductions through deep cuts in branches and staff or other efficiency measures.
Some fear that this plan could prolong the financial crisis by forcing strong banks to
take on the problems of weaker banks. In June 1998, for example, the government closed
five commercial banks, but had healthier banks take over the assets. While the merged
banks are under orders to restructure and cut costs, no plans have been announced.
Corporate Reforms. Efforts to restructure Korea’s banking sector are also
intertwined with corporate sector reforms. The main problems deal with an incredibly high
corporate debt level and weaknesses in corporate governance, especially in the dominant
Large Korean companies rely on debt as their main source of financing with
extraordinarily high debt levels. The level of corporate debt in Korea has been estimated
by the IMF to be between $500-$600 billion, of which $60 billion is external debt. Short
term liabilities accounted for half the total, making Korean companies vulnerable to
economic downturns, changes in interest rates, and changes in creditor perceptions.
The vulnerability of Korean companies to cyclical downturns is intensified by their
ownership and financial structures. A non-transparent structure, combining a large number
Lee, Kyung-Tae. “Korea’s Economic Transition: A New Growth Paradigm,” Korea4
Economic Institute of America Economic Update, Volume 9, Number 4, November 1998, p. 2.
of affiliates with cross shareholding and debt payment guarantees, makes the failure of one
or two companies a threat to the viability of the entire chaebol.
Top priority is being given to the reform of the five largest chaebol (Hyundai,
Samsung, Daewoo, Lucky-Goldstar, and Sunkyung), given the huge role they play in the
overall Korean economy. In what is called the “Big Deal,” the government is pressuring
the chaebol to swap businesses. For example, Samsung has agreed to hand over its car
manufacturing affiliate to Daewoo in return for Daewoo’s electronics unit. Also in an
effort to eliminate duplication and become more specialized, the chaebol leaders have
agreed to cut the number of their subsidiaries nearly in half. The proceeds from the sale
(an estimated 20 trillion won or $16 billion) of these non-core companies will be used to
reduce corporate debt. The chaebol leaders have also reaffirmed deadlines set for
preparing consolidated financial statements in 1999 and for unraveling their cross-
subsidiary loan guarantees by March 2000. 5
While President Kim Dae Jung has been taking a leading role in pushing the chaebol
leaders to implement substantial reforms, many analysts caution that underlying problems
of overcapacity and politically directed credit need to be addressed. Under this view, true
restructuring involves shutting down money-losing enterprises. The closing of plants and
reduction of excess capacity, of course, is vehemently resisted by both corporate captains
and organized labor.
Labor Reforms. The government’s efforts to liberalize the labor market by passing
new labor laws or strictly enforcing labor laws with regard to strikes have faced
considerable resistance. The labor market has been very rigid because of the tradition of
lifetime employment. While trade unions appeared to accept an end to lifetime employment
guarantees in February 1998 based on the promise that chaebol owners would give up
some of their economic power and make themselves more accountable, efforts to push
through reform have been hampered by political stalemate and the lack or inadequacy of
state unemployment benefits. The opposition Grand National Party, with close links to big
business, has attempted to weaken a number of labor reform proposals.
In order to maintain social stability during the reform process, the government has
been broadening unemployment benefits. As of October 1, 1998, unemployment insurance
was expanded from coverage of only those displaced workers who lost their jobs at large
corporations to coverage of all displaced workers. In addition, the government has
budgeted an excess of 10 trillion won ($8.5 billion) for social welfare purposes. If the
chaebol begin shutting inefficient plants and laying off workers on a significant scale,
demand for social services and unemployment benefits could soar.
U.S. Economic Interests
South Korea’s economic crisis will have both short term and long term consequences
for U.S. economic interests. On balance, the effects are likely to be mostly adverse in the
short term, but more favorable over time.
Lee, Charles S. “Chaebols Again Promise Kim They Will Reform,” Far Eastern Economic5
Review, p. 52.
Korea’s economic crisis will have the most immediate effect on U.S. exports and
imports. Contraction of the Korean economy and depreciation of the won reduced
demand for U.S. exports in the first 10 months of 1998 by 41%, dropping U.S. exports
from $21.6 billion in 1997 to $12.6 billion in 1998. All major U.S. export sectors - capital
goods, consumer goods, and agricultural products - were affected. South Korea dropped
from being the fifth largest country market for U.S. exports in 1997 to being the 10th
largest market in 1998.
At the same time, U.S. imports from South Korea continued at 1997 levels ($19.7
billion in exports through the first 10 months of 1998 compared to $19.3 billion during the
same period of 1997). U.S. imports from South Korea are concentrated in steel,
computers, cars, and video equipment. Among these sectors, steel imports surged by
more than 125% over 1997 levels.
As a result mostly of the steep drop in U.S. exports to South Korea, the U.S. trade
surplus with Korea, which totaled $1.9 billion in 1997, moved to a deficit position of
about $7 billion in 1998. This reversal came after a sustained upward trend over the past
South Korea’s trade surplus with the United States can be expected to grow in 1999.
On the one hand, Korean demand for U.S. exports of machinery and industrial inputs is
likely to remain depressed as the Korean economy remains in recession for most of the
year. On the other hand, U.S. demand for Korean goods is likely to grow due to continued
U.S. economic growth and the increased price competitiveness of Korean exports. The
rising trade deficit, in turn, is likely to lead to increased political pressures to limit Korean
export surges in particular sectors, as well efforts to improve market access for U.S.
exports to Korea.
Political pressures to limit Korean exports are being felt in the steel sector. A number
of U.S. steelmakers and unions are pressing the Clinton Administration to impose quotas
of steel imports, which grew overall by 30% in the first 10 months of 1998. Korean
exports have been singled out by U.S. steel interests due to their 86% increase in 1998 and
long-standing allegations that Korean steel producers have benefitted from low-interest
loans and subsidies from the Korean government.6
U.S. steelmakers and workers have also alleged that unfair subsidies were provided
to Hanbo Steel, Korea’s second largest steel producer. According to industry sources,
Hanbo’s access to credit on preferential terms enabled it to undertake construction of one
of the largest integrated steel mills in the world . Hanbo collapsed in January 1997, but
the South Korean government allegedly continued to provide grants so that Hanbo could
continue its operations. The U.S. steel industry and congressional steel caucuses have
repeatedly pressed the Clinton Administration to address these concerns of unfair
competition. In the omnibus spending bill passed in October 1998 (P.L. 105-277),
Congress directed (section 621) that the Office of the United States Trade Representative
report to Congress within 60 days on the Korean government’s support for Hanbo and its
Burton John. “Koreans Cut Steel Exports To Stave Off Clash With US,” Financial Times,6
January 12, 1999, p. 7.
Administration trade officials historically try to deflect pressures to limit import
penetration in key sectors by increasing efforts to open up markets to U.S. exports.
Better market access conditions for U.S. exports is viewed as a way of minimizing the
political fall-out from a rising bilateral trade deficit. Efforts along these lines in certain
sectors, particularly automobiles, could prove difficult. Even though the Korean
government has recently pledged to lower tariffs, and eliminate other discriminatory
barriers, the drop in projected demand for automobiles in Korea means that trade in this
sector will remain sensitive. In 1997, for example, U.S. automobile exports to Korea
totaled $83 million, while Korean automobile exports to the United States totaled $1.9
billion, for a $1.8 billion deficit.
Longer term, assuming Korea returns to a position of sustained growth, U.S.
economic interests should be substantially enhanced. A major reason is that the kinds of
changes that Korea is being required to undertake under the IMF program are basically
congruent with longstanding U.S. trade and investment liberalization objectives. These
entail a much more open market, including elimination of trade-related subsidies, and
restrictive import licenses. They also include greater transparency in both Korean
corporate and governmental decision-making, wider participation by U.S. companies in
the Korean economy, and less policy-driven bank lending which in the past had given rise
to overcapacity in industries such as steel, automobiles, semiconductors, and shipbuilding.
Perhaps the most promising changes have occurred in the area of foreign direct
investment. In an effort to attract more foreign direct investment as a way of fueling
Korea’s economic recovery, the Kim Administration has enacted sweeping changes in its
foreign direct investment regime. Buttressed by an “attract foreign capital” motto, all
limits on foreign investment in the local bond and money markets have been lifted, and the
ceiling on foreign investment in the stock market has been eliminated. Foreign banks and
securities companies have gained the right to establish local subsidiaries. In June 1998,
the Korean government allowed hostile takeovers of Korean corporations by foreigners
to take place without any reservations. Restrictions on foreign ownership of land have also
been eliminated. 7
Combined with cheaper asset prices, the liberalized environment contributed to a
record amount of foreign direct investment in 1998. The nearly $9 billion invested by
foreigners in Korea during 1998 was more than one-third the entire amount invested in
Korea since the mid-1960s. While the U.S. share of foreign direct investment in Korea
remains around one-third, South Korea’s growing receptivity to foreign investment could
lead to a much larger U.S. corporate presence in Korea over time.
Lee, Charles S. and Michael Vatkiotis, “South Korea Warms Towards Foreign Investors,”7
Far Eastern Economic Review, December 24, 1998, p. 51.