The Korean Crisis
Reports
The Korean Crisis
Keywords Crisis,Economic conditions, Korea
The financial crisis which struck Korea in the late fall of 1997 was the result of a complex web of interrelated factors, internal and external. Some of the origins of Korea's crisis go all the way back to the beginnings of the country's economic development. As Korea had largely followed a model where the government played a leading role, the government made all of the most important decisions for both financial institutions and manufacturers. Korea never therefore developed the kind of financial expertise that would one day be required for an open economy under the WTO system.
Korea's position was therefore rather precarious in the wake of the financial liberalization and market opening that had been pursued in recent years, often under strong pressure from advanced countries. The volume of capital inflows surged, and the greater share of them were short-term. This gave rise to an investment boom and a current account deficit, setting Korea up for a major fall. And that fall came when the Southeast Asian crisis proved contagious and spread to other countries.
Moral hazard on the part of borrowers in Korea and foreign lenders also played a major role in the crisis, as had the herd behavior of the latter. Without any international framework to supervise international lenders' operations and without adequate financial supervision in emerging economies, a crisis seemed almost destined to occur in Korea and elsewhere. And when it began, the herd behavior gave rise to a bank-run equilibrium. What is clear from the Korean experience is that, in this increasingly integrated global economy, there is an urgent need for the establishment of international supervisory and enforcement systems, and a lender of last resort. Until these public goods are provided, emerging economies may have no choice but to go back to more restrictive regimes of financial and capital account regulation.
