Financial Liberalisation and Institutional Incompatibility: The Unresolved Dilemma of the Korean Economy

Abstract

Using a ‘varieties of capitalism’ approach, this article explains the ongoing contradictions of the Korean economy in terms of institutional incompatibilities between the liberalised financial system and the most important institutional legacy of the Korean developmental model: the chaebol system. Using its control over financial resources, the developmental state supported, monitored and disciplined the chaebol. Since the 1990s, financial liberalisation has been incompatible with the chaebol system. The liberalised financial system has tended to heighten risks or to dampen vitality within the system. Thus, despite attempts at reform, the failure to rectify these incompatibilities has led to an overall weakening of the Korean economy.

Keywords

Korea financial liberalisation varieties of capitalism

South Korea (hereafter referred to as ‘Korea’) has been identified as one of a small number of developing countries to achieve rapid economic development; however, after the Asian financial crisis of 1997, the Korean economy has experienced difficulty in re-boosting economic growth and restoring economic competitiveness. By and large, the post-crisis debate on Korean political economy has been dominated by the battle of ideas between neoliberalism and developmentalism. The neoliberal interpretation has tended to focus on exogenous factors to liberal financial markets, assuming that financial markets would fundamentally work as an efficient self-regulating market. According to this view, the cronyistic characteristics of the developmental model (such as the chaebol system and its cozy relationship with the government) have not been completely dismantled, so that ‘the routines and practices, organizational forms, and social ties’ that were established under the developmental model have lingered and continue to have detrimental impacts on the Korean economy (Chang, 2003; Cho, 1999). In contrast, according to the developmentalist interpretation, financial liberalisation and the emerging liberal regime during the 1990s has not only made the Korean economy vulnerable to financial flows and but has also continuously constrained the Korean economy (Shin and Chang, 2003; Weiss, 1999).

In this article, I attempt to overcome the neoliberal-developmentalist binary by focusing on the interrelationship between institutional components as a cause of problems rather than a single aspect of the Korean economy. I largely agree with the arguments of Shin and Chang (2003) and Shin (2014) that uncoordinated overinvestment caused by financial liberalisation brought the Korean economy into the financial crisis in 1997, while after the crisis liberal regulatory financial reforms have induced under-investment in the corporate sector. However, while their argument focuses on financial risks and/or constraints caused by liberal financial systems, I emphasise institutional relationship between liberal financial systems and the most important institutional legacy of the Korean developmental model – that is, the big business group called the chaebol system.¹ The crisis and difficulty of the Korean economy can be better explained by contradictions between financial liberalisation and the chaebol system rather than the risks and/or constraints of liberal financial systems per se.

For this purpose, I explain the Korean economy from a ‘varieties of capitalism’ (VoC) perspective. According to this perspective, the relative efficiency of an institutional order depends on the arrangement and interactions of different component institutions within that order since the effect of an institution can differ depending on the existence of other complementary institutions (Amable, 2000, pp. 655–658). In the words of Hall and Soskice (2001, pp. 17–18), ‘two institutions can be said to be complementary if the presence (or efficiency) of one increases the returns from (or efficiency of) the other’. More specifically, there are two different types of institutional complementarity: supplementarity and synergy. The former means that ‘one institution makes up for the deficiencies of the other’, while the latter is the ‘mutually reinforcing effects’ of a set of institutions (Deeg, 2007, p. 613). It is important to note that it is not easy to secure both types of complementarity simultaneously, especially in terms of investment coordination that is essential to both economic growth and stability. While it is important to provide credit to businesses in order to promote economic growth, excessive credit inflows could result in economic problems such as financial bubbles and/or overproduction, which in turn could jeopardise economic stability.

In the case of the Korean economy, of particular importance is the relationship between the financial system and the chaebol system. The chaebol system was established during the developmental model era and has persisted, with some minor changes to its structure, up to the present day, thereby giving a path-dependent characteristic to Korea's economic institutional change. Using its control over financial resources, the developmental state encouraged private firms to invest in industries, to which they would have not devoted their resources without the impetus provided by the state because of high uncertainty and risks associated with large-scale investment and long gestation periods. In addition, in the course of fulfilling developmental plans devised by the state, some Korean private firms grew into the chaebol that had a high reliance on debt financing, a horizontal diversified structure, and a centralised and hierarchical decision-making process. However, financial liberalisation since the 1990s has been inharmonious with the chaebol system that was established in the context of a state-controlled financial system, thereby jeopardising or weakening the Korean economy.

The institutional change of Korea's financial system can be conceptualised as a three-stage process:

a state-controlled and growth-oriented financial system;

a deregulated but still growth-oriented financial system, and

a liberal regulatory and stability-oriented financial system.

Each system has been established and maintained by different state forms based on distinct social and political forces. First, during the developmental model era, the developmental state, which was based on the coalition between authoritarian politicians, developmentalist bureaucrats and big business groups, both supported the expansion of the chaebol for promoting economic growth and checked risk that could be caused by the reckless expansion of the chaebol by using its control over financial resources. Second, in the first half of the 1990s when facing intensified competition in a globalised economy, the Korean state was transformed into what Cerny (1997, pp. 258–259) has termed the ‘competition state’ by a coalition among liberal politicians, bureaucrats and big business groups. Focusing more on enhancing the global expansion and competitiveness of Korean firms – especially the chaebol – than guiding industrialisation, the Korean competition state pursued deregulation in the financial sector in order to allow the chaebol to exploit international financial markets. Finally, after the Asian financial crisis, a new political coalition between liberal politicians, the International Monetary Fund (IMF) and foreign investors moved the Korean state towards being a regulatory state, with a focus on market-enabling regulations that would facilitate the proper working of market mechanisms. The guiding assumption was that national economic improvement would result from economic competition and interactions among private actors within the rules of the market economy (Jayasuriya, 2005, p. 384).² In an effort to enhance the soundness of Korean financial institutions and market discipline, the Korean regulatory state sought to establish a liberal regulatory regime and to open Korean financial market to foreign investors.

The core problem of this change can be conceptualised as an institutional incompatibility (or contradiction) between liberal financial markets and the chaebol system. In the first half of the 1990s, the Korean competition state allowed the chaebol to exploit international financial markets, thereby increasing the reckless expansion of the chaebol. For instance, foreign debt (most of which was short-term debt in the corporate sector, especially the chaebol) rapidly increased from US$44 billion in 1993 to US$120 billion in September 1997, thereby causing financial fragility in the economy (Arestis and Glickerman, 2002, pp. 240–242; Chang, Park, and Yoo, 1998, p. 738).³ The deregulated liberal financial system, created by the Korean competition state, was incompatible with the chaebol system in that it had no institutional mechanism to control the risky expansion of the chaebol. After the Asian crisis, the problems caused by such an institutional incompatibility took new shape. As the Korean regulatory state sought to establish a liberal regulatory regime to control the chaebol, it resolved supplementarity problems but caused synergy problems. It discouraged the chaebol from investing, which in turn dampened the vitality of Korea's economy growth. For instance, the gross domestic investment ratio decreased from 38.1 per cent in 1996 to 26.1 per cent in 2002 (Lim and Jang, 2006, p. 453).

In applying the VoC perspective to Korea, this article is divided into four sections. The first section briefly explains how the state-controlled financial system nurtured the chaebol during the developmental model era. The second section discusses the deregulatory move in the first half of the 1990s and its impacts on the reckless expansion of the chaebol. The third section deals with the newly established financial regulatory regime following the Asian financial crisis that reduced the risk of the chaebol but dampened their vitality. This is followed by concluding remarks.

Korean developmental model and the chaebol system

The Korean developmental model was different from both the liberal market economy (LME) in which diffuse investors in the stock market control business investment strategies, and the co-ordinate market economy (CME) in which banks play a key role. As Chang (1993) has argued, the state, with its control over financial resources, played a key part in investment management in the developmental model. In this respect, while coordination among private actors through non-market mechanisms is central to the typical CME model, it is the coordination between the state and business groups that underpinned the Korean developmental model. The relationship between the developmental state and business groups has been understood in terms of an ‘embedded autonomy’ (Evans, 1995) or ‘governed interdependence’ (Weiss, 1995). While formal and informal networks between the state and businesses were vital to their connectedness, state control over finance was what enabled the Korean developmental state to support, monitor and discipline private businesses.

The Korean developmental state's main instrument for rapid industrialisation was its industrial policy based on its control of finance. The core feature of this industrial policy was to provide firms – whose economic performance met the standards set by the state with comprehensive economic incentives, of which subsidised loans with much lower interest rates, called ‘policy loans’, were of great importance (Amsden, 1989, p. 63).⁴ Policy loans were allocated on the basis of firms' economic performance rather than political connections. In return for government support, private firms were required to increase their output and/or export levels according to the yardstick set by the state. Those failing to meet such performance-based criteria usually lost their access to policy loans and other incentives (Chang, 1993, p. 141; Rodrik, 1995, pp. 86–87). In this respect, the subsidies used for industrial policy were what Weiss (1995, pp. 607–608) has termed ‘disciplined support’. Combining subsidies with discipline, the developmental state was not only able to avoid the waste of resources that was often caused by subsidises, but it could also impose its standards on private firms and influence their decisions over what, when and how much to produce (Amsden, 1989, pp. 143–144; Onis, 1991, pp. 112–113).

The chaebol that were fostered by industrial policy took the following organisational forms, not only to better fulfil developmental plans and thus secure subsidies provided by the state, but also to compete with superior forerunner firms in developed countries (Shin and Chang, 2003, pp. 27–28). First, in terms of financing, they relied heavily on debt because policy loans were the most important subsidy. Debt financing made it easier for them to venture into new industries that the state considered strategically important in economic development. Second, they had a horizontal diversified structure in which the financial, technological and human resources of affiliated firms were interchanged. This horizontal diversification had the advantage of using existing resources when starting a new business and thus more easily responded to the state's developmental plans. Third, business groups were centrally controlled by family owners. The centralised and hierarchical structure, which was similar to the bureaucratic structure of the developmental state, made it easier to concentrate resources within the group on a specific sector that had been given priority at a given point in time. A centralised hierarchy also facilitated consultation with the state by enabling prompt decision making and simplified procedures (Chang, 2003).

Globalisation and deregulated financial system

By 1979, the Korean developmental model was in serious jeopardy. In the early 1980s, several liberal-oriented economic bureaucrats – many of whom were trained in American universities – blamed economic problems on state-led industrialisation and proposed economic stabilisation and liberalisation programmes as a way to solve these problems (Chang, 2001, pp. 197–198; Haggard and Cheng, 1987, p. 125). Although the ideas of liberal bureaucrats foreshadowed the subsequent institutional change in the Korean economy, they were not fulfilled in the 1980s, mainly because the bureaucrats failed to elicit enough political support to ensure the materialisation of their ideas. It was not until 1993 that comprehensive financial liberalisation and the consequent dismantling of the developmental model began to be pursued.

Changing political and economic environments created momentum towards pursuing a more liberal order through economic institutional change. In the late 1980s and early 1990s, globalisation and democratisation made the chaebol clamour more vigorously for financial deregulation. Democratisation enabled labour to increase wage rates in excess of productivity growth rates, while globalisation both intensified international competition in export markets and provided private firms with an opportunity to exploit the large available pool of credit. As a result, the chaebol became more eager to obtain unrestricted access to international financial markets. Access would facilitate their desire to increase investment, thereby ensuring their market share and survival. In addition, as the authoritarian capacity of the state was weakened by democratisation, the power balance between the state and the chaebol changed in favour of the latter.

Although the chaebol pressed vigorously for economic deregulation, their demand for this was selective in that they sought to remove cumbersome regulations on their expansion while maintaining those that protected their interests. The Kim Young Sam government of 1993–1997 concentrated its attention on what the chaebol demanded, resulting in economic deregulation as largely intended by the chaebol (Yoo, 1997, pp. 30–31). In particular, financial liberalisation was undertaken irregularly, reflecting the chaebol's interests. The government comprehensively abolished restrictions on the chaebol's access to international markets and thus made them freely able to utilise international loans to increase their investment and market share. In contrast, regulations on foreign investors, who could do damage to the interests of the chaebol, were not prioritised to the same extent, despite strong external pressure for opening the Korean economy.

In 1993, the government announced a blueprint of financial liberalisation which, in the words of Dalla and Khatkhate (1995, pp. 19–20), ‘embarked on a full throttle liberalisation of the financial system’. This blueprint included the majority measures designed to eliminate state control over finance, such as the deregulation of interest rates, the abolishment of policy loans, the introduction of market principles for monetary and credit policy, and, most importantly, the liberalisation of the external capital account, which ‘Korea's previous plans for financial liberalisation had characteristically failed to include’ (Chang, Park and Yoo, 1998, p. 736). In hindsight, among the various measures implemented by the Kim Young Sam government for financial liberalisation the most important was the easing of the restrictions on foreign borrowing. This easing of restrictions was important not only because it provided unrestricted access to international financial markets that the chaebol were most eager to achieve, but also because the massive accumulation of short-term foreign debt by the chaebol was the fundamental cause of the 1997 financial crisis.

With money borrowed from abroad, the chaebol rapidly increased their facility investment, especially in the manufacturing sector. The annual rate of increase in facility investment had declined from 44.7 per cent in 1973–1979, to 20.5 per cent in the 1980s, and to 12.3 per cent in 1990–1993, but rebounded to 38.5 per cent in 1994–1996. In particular, it grew at the rate of 56.2 and 43.5 per cent in 1994 and 1995, respectively. This renewed investment boom was led by large chaebol firms who increased their investment by 45.7 per cent per annum, especially by expanding their existing production lines in the manufacturing sector (Haggard and Mo, 2000, pp. 200–204; Jeong, 2004, p. 65). In addition, under the banner of ‘global management’, the chaebol also attempted to be multinational corporations, especially in the semiconductors, electronics and automobiles sectors, by investing in overseas markets. For example, Daewoo Motors formulated a plan to increase its capacity to produce 2 million units (1 million at home and 1 million abroad) and established eleven car assembly plants as well as many part plants in ten countries by 1996 (Jeong, 2004, pp. 156–157).

This deregulatory change under the Kim Young Sam government resulted in a financial catastrophe in 1997. The Korean development model was very successful in generating economic development precisely because it was a ‘relatively high-risk-taking system’, the core of which was the debt-based rapid expansion of the chaebol (Wade and Veneroso, 1998, pp. 7–9). The state played the role as ‘the ultimate system manager’ to maintain economic stability, but financial liberalisation weakened such a risk management system (Shin and Chang, 2005, pp. 425–426). The core problem of this change can be conceptualised as an institutional incompatibility (or contradiction) between the deregulated financial market and the chaebol system.

The chaebol system aimed to aggressively expand investment and to venture into new industries through debt financing. Therefore, it always risked causing reckless overinvestment and accumulating high levels of debt. Relying largely on comprehensive financial regulations, the developmental state supplied cheap credit to the chaebol, and controlled the tendency towards recklessness of the chaebol system by socialising the costs that such risky behaviour could incur. Financial deregulation did not harm the strength of the chaebol system as members were able to obtain cheaper credit from international financial markets. However, it made it impossible for the state to control the chaebol's tendency for overexpansion and thus caused an institutional vacuum in offsetting the deficiencies of the chaebol system. In other words, an institutional incompatibility between financial deregulation and the chaebol system resulted in an institutional vacuum for controlling the aggressive expansion of chaebol investment through debt financing. In the absence of government regulations, the chaebol expanded their investment and accumulated massive short-term foreign debt, resulting in rampant debt-led overinvestment and overproduction (Palat, 2003, p. 190). This unchecked activity of the chaebol eventually led to the financial crisis of 1997.

Asian financial crisis and financial regulatory regime

There was an institutional incompatibility (or contradiction) between financial deregulation and the debt-based diversified structures of the chaebol. The Kim Young Sam government largely abolished government control over finance and the chaebol, but did not establish a new institutional mechanism to impose market discipline. Therefore, as Pirie (2012, p. 379) has pointed out, ‘maintenance of the status quo was not an option. Rather, there had to be a move toward further liberalization and an opening up of the sector, or the restoration of dirigiste controls.’

After the crisis, there were efforts to resolve this institutional incompatibility and to fill the consequent institutional vacuum in a liberal way. In order to prevent the chaebol from arbitrarily using financial resources, as well as to make the Korean financial system less vulnerable to crises, the Kim Dae Jung government of 1997–2002 reoriented financial institutions towards the cautious assessment of risk and profitability, rather than the old routines and customs inherited from the developmental model. It endeavoured to establish a new financial regulatory regime, consisting of liberal rules which were based on the so-called ‘international standards of best practices’ and an integrated regulatory body that would enforce such rules on financial institutions independently of the influence of both the state and the chaebol. It also attempted to completely open the Korean economy to foreign investors, who were expected to take over and manage some Korean financial institutions on the basis of international standards as well as imposing market discipline on Korean firms that were seen to deviate from such standards. In this regard, along with the newly created regulatory authorities, foreign investors were understood as part of the new regulatory regime and were to play a role in ensuring that liberal rules were followed. In other words, in addition to serving as a de jure financial regulatory body, foreign investors were expected to be a de facto enforcer of liberal standards through their financial resources in the markets.

On 29 December 1997, the National Assembly passed the Act for the Establishment of Financial Supervisory Organisations, to provide a legal basis for the creation of a new financial regulatory body. By unifying the four existing financial supervisory agencies, the Financial Supervisory Commission (FSC) was created on 1 April 1998 and the Financial Supervisory Service (FSS) was established as an executive arm of the FSC on 1 January 1999. The FSC and FSS were empowered to exert regulatory power over financial institutions and markets. They were authorised to devise and revise rules regarding the supervision of financial institutions, to issue and revoke the licenses of financial institutions, to investigate financial institutions and impose legal enforcement, and to oversee the economic restructuring after the crisis (Choi, 2002, pp. 270–271). The FSC and FSS were principally composed of independent members, appointed for a fixed term in order to free them from political influence and thus enable the organisations to pursue more rule-based regulations (Jung, 2009, p. 716; Pirie, 2008, pp. 113–114). Some argued that the FSC played a similar role to that of the Economic Planning Board (EPB) during the developmental model, which was said to indicate ‘the resurrection of the state-controlled financial sector of the developmental era’ (Jang, 2001, p. 12). It is, however, misleading to identify the FSC with the EPB. Not only was the FSC more insulated from political influence than the EPB, it was also grounded in a different operating principle from that of the EPB. In dealing with economic crises, the EPB had taken on the ‘anti-finance/pro-industry’ stance. In contrast, the FSC adopted the ‘pro-finance’ stance as its main principle (Chang and Yoo, 2000, pp. 119–120). Unlike the EPB, which had given priority to maintaining a high level of investment and economic growth, the FSC was much more concerned with financial stability.

In addition, although it was the intervention of the IMF that catalysed institutional change with regards to opening Korean financial markets to foreign investors, the Kim Dae Jung government saw the role of foreign investors in the Korean economy as a permanent feature of a new liberal economic order that would enforce market discipline in the corporate sector by driving and maintaining the convergence of business and financial management practices with global standards (Pirie, 2008, pp. 141–142). In the past, government restrictions on inward foreign investment were seen as one of the important institutional measures to promote national industry and economic development. Despite the promotion of globalisation as the new economic framework shaping the Korean economy, the Kim Young Sam government had also maintained relatively strict regulations on inward foreign investment, while strongly promoting the outward foreign investment of Korean firms. In contrast, the Kim Dae Jung government changed the main purpose of the regulatory framework on foreign investment from ‘control and regulation’ to ‘promotion and support’ (Thurbon and Weiss, 2006, pp. 7–9). For this purpose, the government introduced the Foreign Investment and Foreign Capital Inducement Act, which took effect on 17 November 1998. The Act allowed all types of foreign investment including hostile mergers and acquisitions (M&As). It also expanded the range of sectors in which foreigners could invest.⁵

Along with falling domestic asset values that were caused by exchange rate depreciations and the contraction of domestic demand, financial openings resulted in what Krugman (2000) has called ‘fire-sale FDI’. This resulted in a significantly increased volume of foreign ownership (Athukorala, 2003, pp. 199–200). Most foreign direct investment took the form of cross-border M&As rather than ‘greenfield’ investments, resulting in the globalisation or denationalisation of Korean firms (Hart-Landsberg, 2004, p. 92). Total approved average annual M&As between 1997 and 2001 increased astonishingly by 834 per cent, as compared to the figure between 1990 and 1996. As a result, while the total amount of FDI inflows into Korea between 1970 and 1997 amounted to US$25 billion, the amount of FDI inflows during 1998 and 2008 was US$124 billion (Athukorala, 2003, p. 206; Park and Mah, 2011, p. 253).

With the rapid increase of foreign investment, many Korean firms and banks came to be controlled by foreign investors. For instance, in the automobile industry, three of the five major firms – Daewoo, Samsung and Ssangyong – were acquired by foreign investors. The proportion of foreign-owned shares in all the listed companies in the Korean stock exchange also significantly increased from 13 per cent in 1996 to 41.97 per cent in 2004 (Lim and Jang, 2006, p. 452). In particular, the banking sector was largely dominated by foreign investors. With the intervention of the IMF and the government's decision to open the Korean economy to foreign investors, the foreign ownership share of the eight largest Korean banks rapidly increased from 12 per cent in 1998, to 39 per cent in 2003 and 64 per cent in 2004.⁶ By mid-2005, the share of foreign investors in important individual banks accounted for 63 per cent of Shinhan Bank, 74 per cent of Korea Exchange Bank, 76 per cent of Hana Bank, 84 per cent of Kookmin Bank and 100 per cent of both Korea-America Bank and Korea First Bank (Park and Mah, 2011, p. 258).

Deregulatory liberal economic transformation in the first half of the 1990s was intended to encourage the global expansion of the chaebol, and thus heightened the risks engendered by the system. In contrast, regulatory liberal changes after the crisis focused on preventing the reckless expansion of the chaebol. However, this had detrimental impacts on industrial expansion. While the Korean economy rebounded in a relatively short period of time, the negative effects of the crisis continued to restrain economic growth primarily because of low-level investment rates (Barro and Lee, 2003).

First, foreign-owned banks changed the nature of the Korean banking sector into what can be called a ‘market-based banking system’. Market-based banking ‘undermines the central position of relational banking by increasing the position of market considerations relative to long-term bank business decisions, where a bank sacrifices short-term profitability in the expectation of subsequent recompense’ (Hardie et al., 2013, p. 696). Foreign-owned banks reduced loans to the corporate sector while increasing loans to households in order to reduce financial risks and earn stable profits. For instance, the proportion of household loans in the total loans of deposit banks increased from 32.6 per cent in 1997 to 56.3 per cent in 2005. This change negatively affected corporate investment that had been supported by bank loans (Kang, 2003, pp. 21–22, 2009, pp. 258–260).⁷ Second, due to the increasing prominence of foreign investors in the Korean economy that was associated with new financial rules based on shareholder capitalism, the chaebol were pressured to focus on increasing dividends and stock prices in the short term and to avoid industrial investments that usually had a relatively long gestation period in order to maintain their ownership and management rights.⁸ For instance, the ratio of stock dividend payouts to investments in the facilities of listed Korean companies increased from 3.7 per cent in 1998 to 22.4 per cent in 2002 (Lim and Jang, 2006, p. 453).

Once again, the newly established financial regulatory regime was also incompatible with the chaebol system in terms of synergy. Although it helped to reduce the risk tendencies of the system, the new regime dampened the rapid expansion of the chaebol, which had previously enabled the rapid development of the Korean economy. With its primary focal points centred on risk reduction and maintaining financial stability, the newly established financial regulatory regime tended to choke the vitality of the chaebol system. As a result, the Korean economy has not recovered to pre-crisis investment ratios.

Concluding remarks

Other Southeast Asian economies also suffered from the Asian financial crisis. In these countries, financial liberalisation and/or crony capitalism could be regarded as the general causes of their economic problems. However, crises usually take different shapes depending on domestic institutional arrangements. For example, there was an important difference between the other Southeast Asian countries and Korea. In Southeast Asian countries, most foreign short-term loans were speculatively used to invest in property (and stock) markets, whereas in Korea, foreign loans were used by Korean firms, especially the chaebol, to expand their production facilities (Henderson, 1999, pp. 329–330). This difference could be attributed to domestic institutional arrangements. In this respect, in order to grasp the concrete aspects of economic problems and the related solutions, we need to understand the precise institutional arrangements of each economy.

One of the main dilemmas of Korea's economic institutional arrangement since the 1990s has been an institutional incompatibility between liberalised financial systems and the chaebol system. An institutional complementarity between the state-controlled financial system and the chaebol system had been integral to Korea's rapid economic development. It not only encouraged the chaebol to invest and expand rapidly, but also disciplined them in order to prevent their reckless behaviour. However, the deregulatory move in the first half of the 1990s caused an institutional vacuum that allowed for the reckless expansion of chaebols, thereby leading to the financial crisis of 1997. In contrast, the new regulatory regime after the crisis contributed to regulating the chaebol. However, this dampened the vitality of the chaebol and lead to sluggish economic performance.

Korea's economic institutional change is still an ongoing issue since both political elites and the general public are aware of its necessity for solving the economic problems that many Koreans are now facing. As a part of this ongoing political project, one of the important tasks is to find a way to rectify the apparent institutional incompatibility between liberal financial orders and the chaebol system. This could be accomplished either by reforming financial regulations or by adapting the chaebol to the liberal financial system. Therefore, one of the important issues facing the Korean government is whether to give priority to the liberal financial system or the chaebol system in dealing with economic problems. In sum, the Korean economy will be significantly affected by political decisions on whether to change the liberal financial system or the chaebol system in order to solve the institutional incompatibility between them.

Footnotes

Acknowledgements

The author would like to thank the two anonymous reviewers for their critiques and comments. This work was supported by the National Research Foundation of Korea Grant funded by the Korean Government (NRF-2013S1A3A2054523).

1

, pp. 88–90) even has argued that in hindsight, the projects of the cheabol before the 1997 financial crisis were not overinvestment and their ‘overall investment decision was not at fault’.

2

We need to distinguish between ‘liberal’ or ‘market-enabling’ and ‘restrictive’ or ‘market-inhibiting’ regulations (or policies). The former aims to facilitate and maintain the proper working of market mechanisms, while the latter seeks to restrict and distort market mechanisms (Harmes, 2006, p. 76, n. 3; Hopkin and Blyth, 2012, p. 6).

3

According to an estimate, during 1993–1996, more than US$120 billion of international capital went to the chaebol through Korean commercial banks, non-banking financial institutions and the chaebol's own offshore subsidiaries (Jeong, 2004, p. 73).

4

Policy loans accounted for 57–59 per cent of total bank loans between 1962 and 1985. Policy loans for working capital were available to any firms engaging in export activities, whereas long-term loans were allocated only to targeted firms and industries (Amsden, 1989, p. 63).

5

In particular, in its first letter of intent to the IMF on 3 December 1997, the government agreed to raise the ceilings on collective foreign shareholdings from 26 to 50 per cent. However, it went much further than the IMF's request by abolishing all the ceilings on foreign shareholdings and allowing hostile M&As. In addition, the legal limit of shares that any investor was allowed to buy without obtaining the approval of the current board of directors was increased from 10 to 33 per cent of the total share of a firm (Dent, 2003, pp. 271–272; Kalinowski and Cho, 2009, p. 228).

6

In January 2000, Newbridge Capital became the first foreign financial institution to take over a Korean bank (Korea First Bank). Following Newbridge Capital, the Carlyle Group and Lonestar took over KorAm Bank and Foreign Exchange Bank, respectively. The sale of Korea First Bank to foreign investors may have been seen as part of the agreement with the IMF. However, it was the Kim Dae Jung government's unilateral decision to sell KorAm Bank and Korea Exchange Bank to foreign investors (Lee and Han, 2006, p. 320; Pirie, 2005, p. 365).

7

This change in Korean banks' business strategy was met by the demand of Korean households that relied more on debt to make a living because of neoliberal economic restructuring, especially increased labour market flexibility.

8

As , p. 107) points out, ‘the short-term horizons of institutional investors’ tend to pressure a company's management to fulfil short-term performance objectives.

References

Amable

(2000) ‘Institutional Complementarity and Diversity of Social Systems of Innovation and Production’, Review of International Political Economy 7(4), pp. 645–687.

Amsden

A.H.

(1989) Asia's Next Giant: South Korea and Late Industrialization, New York: Oxford University Press.

Arestis

Glickerman

(2002) ‘Financial Crisis in Southeast Asia: Dispelling Illusion the Minskyan Way’, Cambridge Journal of Economics 26(2), pp. 237–260.

Athukorala

P.-C.

(2003) ‘Foreign Direct Investment in Crisis and Recovery: Lessons from the 1997–1998 Asian Crisis’, Australian Economic History Review 43(2), pp. 197–213.

Barro

R.J.

Lee

J.-W.

(2003) ‘Growth and Investment in East Asia before and after the Financial Crisis’, Seoul Journal of Economics 16(2), pp. 83–118.

Cerny

P.G.

(1997) ‘Paradoxes of the Competition State: The Dynamics of Political Globalization’, Government and Opposition 32(2), pp. 251–274.

Chang

D.-O.

(2001) ‘Bringing Class Struggle Back into the Economic Crisis: Development of Crisis in Class Struggle in Korea’, Historical Materialism 8(1), pp. 185–213.

Chang

H.-J.

(1993) ‘The Political Economy of Industrial Policy in Korea’, Cambridge Journal of Economics 17(2), pp. 131–157.

Chang

H.-J.

Yoo

C.-G.

(2000) ‘The Triumph of the Rentiers?’, Challenge 43(1), pp. 105–124.

10.

Chang

H.-J.

Park

H.-J.

Yoo

C.-G.

(1998) ‘Interpreting the Korean Crisis: Financial Liberalisation, Industrial Policy and Corporate Governance’, Cambridge Journal of Economics 22(6), pp. 735–746.

11.

Chang

S.-J.

(2003) Financial Crisis and Transformation of Korean Business Groups: The Rise and Fall of Chaebols, Cambridge: Cambridge University Press.

12.

Cho

Y.J.

(1999) ‘The Financial Crisis in Korea: Causes and Challenges’ in Rhee

S.G.

(ed.), Rising to the Challenge in Asia: A Study of Financial Markets, Vol. 7, Manila: Asian Development Bank, pp. 1–26.

13.

Choi

J.-W.

(2002) ‘Regulatory Forbearance and Financial Crisis in South Korea’, Asian Survey 42(2), pp. 251–275.

14.

Dalla

Khatkhate

(1995) ‘Regulated Deregulation of the Financial System in Korea’, World Bank Discussion Paper 292, Washington, DC: World Bank.

15.

Deeg

(2007) ‘Complementarity and Institutional Change in Capitalist Systems’, Journal of European Public Policy 14(4), pp. 611–630.

16.

Dent

C.M.

(2003) ‘Transnational Capital, the State and Foreign Economic Policy: Singapore, South Korea and Taiwan’, Review of International Political Economy 10(2), pp. 246–277.

17.

Evans

(1995) Embedded Autonomy: States and Industrial Transformation, Princeton, NJ: Princeton University Press.

18.

Haggard

Cheng

T.-J.

(1987) ‘States and Foreign Capital in the East Asian NICs’ in Deyo

F.C.

(ed.), The Political Economy of the New Asian Industrialism, Ithaca, NY: Cornell University Press, pp. 84–135.

19.

Haggard

(2000) ‘The Political Economy of the Korean Financial Crisis’, Review of International Political Economy 7(2), pp. 197–218.

20.

Hall

P.A.

Soskice

(eds) (2001) Varieties of Capitalism: The Institutional Foundations of Comparative Advantage, New York: Oxford University Press.

21.

Hardie

Howarth

Maxfield

Verdun

(2013) ‘Banks and the False Dichotomy in the Comparative Political Economy of Finance’, World Politics 65(4), pp. 691–728.

22.

Harmes

(1998) ‘Institutional Investors and the Reproduction of Neoliberalism’, Review of International Political Economy 5(1), pp. 92–121.

23.

Harmes

(2006) ‘Neoliberalism and Multilevel Governance’, Review of International Political Economy 13(5), pp. 725–749.

24.

Hart-Landsberg

(2004) ‘The South Korean Economy and US Policy’, Asian Perspective 28(4), pp. 89–117.

25.

Henderson

(1999) ‘Uneven Crises: Institutional Foundations of East Asian Economic Turmoil’, Politics and Society 28(3), pp. 327–368.

26.

Hopkin

Blyth

(2012) ‘What Can Okun Teach Polanyi? Efficiency, Regulation and Equality in the OECD’, Review of International Political Economy 19(1), pp. 1–33.

27.

Jang

(2001) ‘The State Activism toward the Big Business in Korea, 1998–2000: Path Dependence and Institutional Embeddedness’, Paper presented to the Annual Meeting of Midwest Political Science Association, Chicago, IL, 19–22 April.

28.

Jayasuriya

(2005) ‘Beyond Institutional Fetishism: From the Developmental to the Regulatory State’, New Political Economy 10(3), pp. 381–387.

29.

Jeong

S.-I.

(2004) Crisis and Restructuring in East Asia: The Case of the Korean Chaebol and the Automotive Industry, New York: Palgrave Macmillan.

30.

Jung

H.J.

(2009) ‘Financial Regulatory Reform in South Korea Then and Now’, Korea Observer 40(4), pp. 701–734.

31.

Kalinowski

Cho

(2009) ‘The Political Economy of Financial Liberalization in South Korea: State, Big Business and Foreign Investors’, Asian Survey 49(2), pp. 221–242.

32.

Kang

(2003) ‘From the Front Lines at Seoul Bank: Restructuring and Reprivatization’, IMF Working Paper WP/03/235, Washington, DC: International Monetary Fund.

33.

Kang

M.-K.

(2009) ‘The Sequence and Consequences of Bank Restructuring in South Korea, 1998–2006: Too Fast to Adjust’, Asian Survey 49(2), pp. 243–267.

34.

Krugman

(2000) ‘Fire-Sale FDI’ in Edwards

(ed.), Capital Flows and the Emerging Economies: Theory, Evidence and Controversies, Chicago, IL: University of Chicago Press, pp. 43–60.

35.

Lee

S.-J.

Han

(2006) ‘The Demise of “Korea, Inc.”: Paradigm Shift in Korea's Developmental State’, Journal of Contemporary Asia 36(3), pp. 305–324.

36.

Lim

H.-C.

Jang

J.-H.

(2006) ‘Neo-Liberalism in Post-Crisis South Korea: Social Conditions and Outcomes’, Journal of Contemporary Asia 36(4), pp. 442–463.

37.

Onis

(1991) ‘The Logic of the Developmental State’, Comparative Politics 24(1), pp. 109–126.

38.

Palat

R.A.

(2003) ‘Eyes Wide Shut’: Reconceptualizing the Asian Crisis’, Review of International Political Economy 10(2), pp. 169–195.

39.

Park

Mah

J.S.

(2011) ‘Neo-Liberal Reform and Bipolarisation of Income in Korea’, Journal of Contemporary Asia 41(2), pp. 249–265.

40.

Pirie

(2005) ‘Better by Design: Korea's Neoliberal Economy’, Pacific Review 18(3), pp. 355–374.

41.

Pirie

(2008) The Korean Developmental State: From Dirigisme to Neo-Liberalism, London: Routledge.

42.

Pirie

(2012) ‘The New Korean Political Economy: Beyond the Models of Capitalism Debate’, Pacific Review 25(3), pp. 365–386.

43.

Rodrik

(1995) ‘Getting Interventions Right: How South Korea and Taiwan Grew Rich’, Economic Policy 10(20), pp. 55–107.

44.

Shin

J.-S.

(2014) The Global Financial Crisis and the Korean Economy, Abingdon: Routledge.

45.

Shin

J.-S.

Chang

H.-J.

(2003) Restructuring Korea Inc., London: RoutledgeCurzon.

46.

Shin

J.-S.

Chang

H.-J.

(2005) ‘Economic Reform after the Financial Crisis: A Critical Assessment of Institutional Transition and Transaction Costs in South Korea’, Review of International Political Economy 12(3), pp. 409–433.

47.

Thurbon

Weiss

(2006) ‘Investing in Openness: The Evolution of FDI Strategy in South Korea and Taiwan’, New Political Economy 11(1), pp. 1–22.

48.

Wade

Veneroso

(1998) ‘The Asian Crisis: The High Debt Model versus the Wall Street-Treasury-IMF Complex’, New Left Review 228, pp. 3–22.

49.

Weiss

(1995) ‘Governed Interdependence: Rethinking the Government-Business Relationship in East Asia’, Pacific Review 8(4), pp. 589–616.

50.

Weiss

(1999) ‘Globalization and National Governance: Antinomy or Interdependence?’, Review of International Studies 25(5), pp. 59–88.

51.

Yoo

S.M.

(1997) ‘Evolution of Government-Business Interface in Korea: Progress to Date and Reform Agenda Ahead’, Working Paper 9711, Seoul: Korea Development Institute.