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A Silver Lining in Korea's Crisis: New Pledges Signal Hope for Economic Recovery and Peaceful Reunification

Daryl M. Plunk
Senior Fellow
The Heritage Foundation

FYI Number 169
January 15, 1998

 

In December 18, 1997, the citizens of the Republic of Korea elected an opposition leader to the presidency for the first time in South Korea's history. Although the nation has become increasingly democratic since major political reforms were instituted in 1987, the election of Kim Dae Jung represents the first transfer of power from the ruling party to the opposition. When President-elect Kim is sworn in on February 25, the entrenched ruling establishment_whose virtual monopoly of Korea's politics and economy can be traced back nearly two decades_will have been uprooted.

The 74-year-old Kim is well-known around the world for his years of struggle against Korean authoritarianism. He weathered relentless government persecution in the 1970s and 1980s. During that period, he was jailed for six years and spent 10 additional years either under house arrest or in foreign exile. In May 1980, he was sentenced to death for his opposition to a military coup that year. In late 1982, U.S. pressure led to Kim's release and immediate exile to the United States. He subsequently lived in America for two and a half years, spending much of that time in the Washington, D.C., area. Before his victory last month, he had sought the presidency in elections held in 1971, 1987, and 1992.

The victory is bittersweet for the President-elect who, with more than 40 years of public service, has become Korea's ranking political figure. Kim Dae Jung will inherit an economy_once the world's 11th largest_that is on the verge of bankruptcy after decades of central government planning. The Asian economic crisis has riveted U.S. attention in recent months: The current woes in Indonesia, Malaysia, and Thailand could have an impact on the United States, and further deterioration of South Korea's economy could inflict serious damage on America's economic welfare. Thus, U.S. interests will be directly affected by the course the new Korean administration follows. Early indications are that President-elect Kim intends to do what is long overdue in Korea: implement dramatic free-market reforms and throw Korea's protected economy open to foreign investment and competition. 

Although economic issues currently monopolize Korea's center stage, the U.S.-Korea military alliance and the ongoing North Korean threat are important policy challenges for the incoming Korean leader. Since late 1994, the Clinton Administration, breaking with previous U.S. policy toward the communist North, seized the policy lead from Seoul and has attempted to coax the Pyongyang government into a peace process by offering the North an array of concessions and enticements. As a result, the North has shown more interest in improving bilateral trade and political ties with the United States than in securing a stable peace on the Korean peninsula. No substantive breakthroughs have been made, and inter-Korean tensions remain high. With 37,000 U.S. troops stationed in South Korea and facing the North's well-armed, million-man army, U.S. national security interests remain very much at risk in Korea. Just one day after his election, President-elect Kim voiced his resolve to achieve a breakthrough by refocusing on the bilateral North-South dialogue process and pressing Pyongyang for substantive tension reduction.

IMMEDIATE CHALLENGES

The Economic Emergency. The Asian economic crisis receives daily attention around the world. With all major economies tightly intertwined in the global trading system, ripple effects from across the Pacific are having an impact on stock markets from New York to Moscow. Ailing Asian companies and central banks are in danger of defaulting on multibillion-dollar loans held by financial institutions located mainly in Japan, Europe, and the United States.

Last November, South Korea's foreign exchange reserves had fallen to about $8 billion. By year's end, officials there realized that the nation would be out of reserves to service an estimated $100 billion in foreign debt. The teetering economy stumbled into the arms of the International Monetary Fund (IMF), which in mid-December reached a deal offering loans to Korea in installments that eventually would total $57 billion. To date, the IMF has delivered $13 billion of that amount, and Korea has received additional loan assistance from Japan and the G-7 nations.1 Meanwhile, foreign bankers are working with the South Korean government to "roll over" or delay for short periods of time some of the looming loan payment deadlines.

In the domestic market, businesses large and small suddenly were faced with no access to credit. Highly leveraged already, many of these businesses have collapsed. Seven of Korea's massive chaebol_the nation's huge conglomerates, the top 30 of which account for 90 percent of Korea's gross national product (GNP)_went under. Suffering among small and medium businesses is more extensive: The South Korean press has reported that, during the first five days of 1998, more than 500 went bankrupt. Korea's currency has plummeted in value and, in trading against the dollar, currently is worth about half its value of just two months ago.

Korea arose from the Korean War's ruin and built what was, until a few weeks ago, the world's 11th largest economy. Seoul offered its lessons, touted as the "Korean miracle," as a model for developing nations. But Korea's achievements depended heavily upon both central government control of business decisions and massive debts. The government directed Korean commercial banks to fund the chaebol at below-market rates. Korean consumers, on the other hand, often were saddled with interest levels high above market rates. Thus, the government subsidized the chaebol and placed the burden on its citizens. One result is that, lacking access to scarce capital, Korea's small and medium business sector remains weak and underdeveloped. The government further bolstered the large groups' industrialization by closing its domestic market to foreign imports and investment with a tangled web of tariffs, quotas, and burdensome regulations. Korean companies hoarded enormous revenues that were fueled by access to government-directed capital. Last year, Korea's largest company reported revenues of $100 billion, or about 20 percent of the nation's GNP. Some politicians and policymakers who protected and supported this rigged system were rewarded regularly with bribes.

Korea's $500 billion economy became too large to be led efficiently by government bureaucrats. Without the wise "invisible hand" of the free market, bad decisions and policies multiplied. Massive government-blessed investments were made in steel manufacturing, shipbuilding, consumer electronics, semiconductors, and automobiles. Korea is now faced with production over capacity in these sectors and inadequate demand in domestic and international markets. Korea currently has five automakers, for instance, while the United States has three. Since the Korean car market is saturated and Korean auto exports are sagging, this defies business logic; yet just last year, the Korean government gave the go-ahead for the nation's fifth auto company to begin new production.

Led by its government, Korea's goliath conglomerates supported their growth by racking up debt-to-equity ratios averaging 300 percent compared with 30 percent for U.S. Fortune 500 companies. The weight of this debt brought the nation to its knees late last year, and now the IMF is struggling to stabilize the economy through a massive bailout. However, the IMF's bailout record is not one of success. Since 1976, for instance, Mexico has been bailed out four times. In addition, between 1965 and 1995, 89 lesser-developed countries received IMF loans. Yet 48 of them are no better off today than they were before receiving these loans, and 32 of these 48 are actually worse off. In fact, most nations that have received IMF aid have later returned for more. Thus, the IMF has not amassed a record of helping countries achieve long-term prosperity.2

A recent Heritage Foundation study found evidence that "no amount of IMF aid is likely to force governments to make the changes needed to put their economies back on track." Instead, past huge loans were bandages that, far from stopping the bleeding, allowed irresponsible governments "to put off the hard choices they would have had to make without IMF aid."3

The $57 billion IMF deal with Korea has been sealed, and loans are being parceled out to the Seoul government in measured installments. Two factors give rise to hope that this IMF process may be more successful than others in the past. First, the IMF has detailed strict conditions that include sweeping economic restructuring, labor reform, banking reform, and market liberalization. Second, President-elect Kim has expressed his "100 percent" commitment to broad and systematic economic change, stating that "Our new administration is going to [implement] all of these policies not because of the requirement by the international community or the IMF." Rather, he believes his country must seize "this opportunity to reform our economic system so that we can be competitive in the world economy."4 

Given the critical problems Korea is facing, Kim made it clear that action could not wait until his February 25 inauguration. With the consent of outgoing President Kim Young Sam, the President-elect has begun formulating his reform program, and has even secured the sitting President's cooperation in implementing changes before his inauguration. Those reforms include moves to end the nation's "employment for life" tradition and allow necessary layoffs. New regulations also have opened the door to increased foreign investment, allowing non-Koreans to acquire larger equity stakes in Korean companies. Kim has pledged to end lingering tariff and non-tariff barriers to foreign firms, upgrade the country's accounting standards, and ease restrictions on foreign ownership of real estate. In his drive to scale back the bloated chaebol, he intends to strengthen shareholder rights and allow for hostile mergers and acquisitions. All companies will be required to produce transparent and accurate financial statements.

At a time when global confidence in Korea is at a very low ebb, President-elect Kim's message is reassuring. His priorities, he says, are to embrace free-market principles, end government-business collusion, and open Korea's market to foreign trade and investment.

The North Korean Threat. For most of the past decade, democratic allies have celebrated the fall of communism in the Soviet Union and Eastern Europe. But the North Korean conundrum drags on, preventing the free world from pounding the final nail into the Cold War's coffin. Confounding aspirations to establish lasting peace on the Korean peninsula are conflicting opinions and information about the very nature of the Pyongyang regime, its intentions, and the health of its socioeconomic system. Moreover, food aid has become an emotional lightning-rod issue in this debate.

There also are deep divisions regarding current U.S. policy toward the North. Some criticize the Administration's "engagement" policies as too flexible or, worse, as "appeasement." Others support the current approach and point to the recently inaugurated four-way talks among North and South Korea, the United States, and China, and the U.S.-conceived light water reactor construction project in North Korea as evidence of and viable vehicles for tension reduction.

The baseline of President Clinton's policies is the U.S.-North Korea Agreed Framework signed in Geneva in October 1994. One pillar of this deal was containment of the North's threatening nuclear weapons program through offers of generous benefits, including a $50 million per year supply of heavy fuel oil and the construction in the North of two nuclear reactors expected to cost $5 billion. Seoul was asked by Washington to pay the lion's share of that bill. In return, the North agreed to freeze the work of its nuclear energy facilities, thus preventing it from amassing any more weapons-grade fuel. The Clinton Administration backed down, however, from its previous demand that Pyongyang must provide a full accounting of the significant amount of bomb-grade material it possesses. The Administration has admitted it has no way of detecting whether a secret North Korean bomb-making program is underway. Also, although Pyongyang had promised explicitly to resume peace talks with Seoul, it now refuses to do so; the President has looked the other way and continues to uphold America's side of the bargain. The several rounds of U.S.-led four-party talks held late in 1997 merely produced an agreement to meet in March 1998.  

Although it is well into the fourth year of President Clinton's engagement policies toward Pyongyang, no substantive tension reduction has been achieved. Meanwhile, the North poses the world's most serious and immediate threat to U.S. interests_and to those of South Korea. Pyongyang's million-man army maintains its forward deployment. The world's largest array of artillery tubes is massed along the North's border with the South and points at the capital city of Seoul. The North's large stockpiles of chemical weapons are stored near the front and are of grave concern to the U.S. commanders who lead the 37,000 American soldiers stationed in the South.

The North also has a growing missile arsenal capable of striking all parts of South Korea. The Clinton Administration claims it is making progress on the missile proliferation issue in its bilateral talks with the North. However, it is not well-known that, over the course of the past two years, Washington discovered not one but two dangerous sales of North Korean missile technology to rogue nations including Iran_a violation of the spirit if not the letter of the Agreed Framework.

America's economic, political, and security stakes in Northeast Asia are very high. Should the North attempt to make good on its infamous threat to turn the South into a "sea of flames," the entire region would be destabilized. Since the Agreed Framework process has not eased Korean tensions, current U.S. policy fails to protect core U.S. national security interests on the peninsula.

Clinton's policies have done little more than paper over the threat and entice Pyongyang to engage in talks with the United States by offering it a multibillion-dollar energy infrastructure construction and pledges of limited U.S. aid and political ties. Now the United States and other nations are responding to the economic crisis in the North with food aid. For the first time, the North openly admits its economic woes and is appealing publicly for international support. Pyongyang is abstaining from substantive, direct talks with the South in hopes of extracting maximum concessions from the United States and its allies. But this is a futile game. The North's needs are much greater than Washington and Seoul at present are willing to provide. Massive aid to a nation that poses a clear and present military threat is hardly an acceptable option. As the North continues its slide toward economic collapse, it can expect only token aid under the current circumstances. The multibillion-dollar nuclear reactor bonanza it has been promised will not materialize for years.

The Seoul government has grown wary of Washington's flexibility with the North and has criticized U.S. policy several times. This has led to tensions between the two allies. A senior Korean official in late 1996 criticized Washington's policies as "seriously flawed" and amounting to "appeasement."5 In an unusual public display of irritation with Seoul, anonymous Clinton Administration officials were quoted in the press as saying that "in private" they hoped for an opposition presidential victory, complaining of statements by current President Kim Young Sam that "exaggerate" the North Korean threat.6

One of President-elect Kim's pressing tasks is to ease the strains between Seoul and Washington, as well as to press for peace with the North. His statements regarding North Korea have been encouraging and are in line with positions long advocated by Heritage Foundation analysts. He has called on Pyongyang to resume bilateral dialogue with Seoul, suggesting that the stalemate will continue until the North abides by its Geneva agreement to pursue meaningful negotiations. The central focus of those talks, Kim says, should be the Basic Agreements that were ratified by the North and South Korean governments in 1992. Long ignored by the Clinton Administration, these pacts were negotiated by the prime ministers of each side and outline specific and practical steps toward easing political and military tensions.

CONCLUSION

After years of sacrifice in pursuit of Korean democracy, President-elect Kim Dae Jung is preparing to implement the policies and reforms he has advocated for many years. He will take office, however, during one of Korea's darkest hours. One of the President-elect's key advisors told The Heritage Foundation, "The joy of victory did not last very long."

Only a month into the transition process and a month before his inauguration, Kim's actions have been impressive and reassuring. His unequivocal support for free-market reforms, for instance, has sent all the right signals to the international business community. This is critical, since rebuilding investor confidence and inducing foreign investment and financial assistance are keys to Korea's recovery. Kim also has taken the right steps toward formulating new approaches to North Korea that might break the current deadlock. The Republic of Korea has become one of America's most important political, economic, and military allies. During this crisis period, the U.S. government should:

Further U.S. "carrots" should be curtailed until the North ends its refusal to engage the South in peace talks. The silver lining in Korea's financial crisis today is its opportunity to realize comprehensive reform and restructuring in relatively short order. Success in achieving such a transformation also offers other developing nations a model for reform.

Endnotes

1The Group of Seven (G-7) nations are Canada, France, Germany, Italy, Japan, the United Kingdom, and the United States.

2Bryan T. Johnson and Brett D. Schaefer, "The International Monetary Fund: Outdated, Ineffective, and Unnecessary," Heritage Foundation Backgrounder No. 1113, May 1997.

3Bryan T. Johnson and John Sweeney, "Down the Drain: Why the IMF Bailout in Asia Is Wasteful and Won't Work,"  Heritage Foundation Backgrounder No. 1150, December 1997.

4Kevin Sullivan, "S. Korea's Kim Blames 'Lies' for Turmoil," The Washington Post, January 9, 1998, p. A1.

5Daryl M. Plunk, "No Way to Deal with North Korea: The Clinton Administration's Weak Stance Is Making South Korea  Nervous," The Washington Post, September 29, 1996, p. C2.

6Jeffrey Smith, "U.S. Aides Pessimistic on Korea Talks," The Washington Post, October 13, 1997, p. A24.

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