The Prologue: Before the Crisis
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Korea's Pre-Crisis Economy
Before the crisis hit Korea in July, the East Asian economies were some of the fastest growing in the world, and as such they were drawing in a high proportion of international aid and investment capital. To fully understand how Korea and the other East Asian economies fell so hard, one must first look at their economic policies before the crisis hit.
Korea's pre-Crisis economy had several important characteristics. First, the growth that occurred in the decades leading up to the crisis was lead by policies of Export-oriented Industrialization (EOI). This concept is often employed by developing countries, to facilitate rapid economic growth. Essentially, EOI policies encourage a lowering of tariff barriers and artificially manipulating local currencies help to increase international investment. This increase in capital inflow should lead to a boom in exports, which are always products for which the country has a relative advantage at producing (Nam, 10). Over the longer term, the idea is for the economic growth caused by EOI to help make the economy less dependent on external investment, which will make the economy more stable in general. In the case of the Korean economy in the years leading up to the crisis, they were in the middle stages of this process, where outside investment was very high, but the economy was not yet stable enough to survive any fluctuations in the capital inflow.
By 1994-96, the EOI policies that had been adopted more than twenty years before appeared to be having unforeseen effects. Domestic savings could not keep up with external capital inflows, and Korea soon began to run what is known as a current-account deficit. The second main characteristic of Korea’s pre-crisis economy – particularly in the few years before – was a liberalization of both the financial and the monetary institutions that existed (Corbett, 67). The liberalization of financial institutions meant that the system had made certain guarantees about backing investment, which became harder and harder to meet. The liberalization of monetary institutions meant that the system had been based off of a relatively fixed rate of exchange for the Korean won, which was essentially pegged to the US dollar. The fact that internal savings could no longer match external cash-inflows coupled with liberalized fiscal and monetary institutions set the Korean economy up for a serious economic crisis.
Many economists see this pre-crisis economic situation and argue that it was a standard currency crisis that brought about the fall of the Korean economy. Others, however, argue that the Asian economic crisis was unlike any other currency crisis, for several reasons. Paul Krugman’s 1998 article, “What Happened to Asia?” outlined the characteristics of the Asian collapse, and how these characteristics differed from other observed currency crises. First of all, the Korean economy was for the most part well balanced, with low inflation rates and low rates of unemployment. Typically, those economies that are forced to abandon a fixed exchange rate – and thus suffer a currency crisis – are marred by very unstable investment and high unemployment. In addition, the country’s financial players appear to have been central players in the increasing vulnerability, whereas in past crises, it is the financial players which try to balance out the effects.
