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The Korean financial crisis: implications for international business in

Korea
O. Yul Kwona
a
Griffith University,

To cite this Article Kwon, O. Yul(2000) 'The Korean financial crisis: implications for international business in Korea',
Asian Studies Review, 24: 1, 25 — 50
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 Asian Studies Review. ISSN 1035-7823
Volume 24 Number 1 March 2000

THE KOREAN FINANCIAL CRISIS:

IMPLICATIONS FOR INTERNATIONAL
BUSINESS IN KOREA1

O. YUL KWON
Griffith University

INTRODUCTION
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After its successful performance over the last three decades, the South Korean
economy experienced a financial crisis in November 1997, and required
assistance from the IMF.2 South Korea (hereafter Korea) now faces the burning
question: why did the financial crisis occur? This question has been extensively
discussed in the literature (Cha 1999; Jwa and Yi 1999; Kwon 1998; Norton 1998;
Warne 1998). Another important issue is the implications of the crisis for inter-
national business in Korea. This issue has attracted little attention, although it is
likely that a country's international business environment is closely related to
that country's vulnerability to financial crisis. In essence a currency crisis in a
country arises from its business relations with other countries. Korea was reputed
to be one of the most difficult places in which to do business before the 1997
financial crisis. Will such difficulties be ameliorated as a result of this crisis?
This paper attempts to appraise the possible changes in Korea's international
business environment as a result of the 1997 financial crisis and the subsequent
recovery process. To this end, issues such as the causes of the Korean financial
crisis, the process of remedying the crisis, and its recovery prospects must be
addressed, as these factors have a direct bearing on Korea's business environ-
ment. The purposes of this paper are therefore: (a) to examine the difficulties
experienced by foreigners in doing business in Korea before the 1997 financial
crisis; (b) to relate these difficulties to the causes of the crisis; (c) to examine the
ways in which these difficulties are addressed in the remedial process; (d) to
assess the recovery prospects of the Korean economy; and (e) to appraise the
developments in Korea's international business environment following the
financial crisis.

© Asian Studies Association of Australia 2000. Published by Blackwell Publishers, 108 Cowley Road,
Oxford OX4 1JF, UK and 350 Main Street, Maiden, MA 02148, USA.
 26 O. Yul Kwon

INTERNATIONAL BUSINESS ENVIRONMENT PRIOR

TO THE 1997 CRISIS
Trade barriers
Korea was regarded as the most difficult market in Asia prior to the 1997 financial
crisis, according to the International Institute for Management Development
(IMD), (Booz.Allen & Hamilton 1997, 28). Korea embarked on an industrialisation
policy during the 1960s, coupled with protection of the strategic manufacturing
sector and the agricultural sector from foreign competition. In the mid-1980s,
the government began to take serious measures to open and liberalise the
economy, largely because of pressure from Korea's trading partners. However,
there was a general consensus among foreigners that imports of consumer goods
were strongly discouraged (Booz.Allen & Hamilton 1997, 24). Sohn (1997, 219)
argued that although Korea was one of the signatories of the WTO in 1994 and
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joined the OECD in 1996, it had yet to implement further trade liberalisation
by undertaking reforms and deregulation to conform to the WTO system. Korea
maintained an import source diversification policy that in essence blocked cer-
tain imports from Japan in an effort to reduce its chronic trade deficit with that
country. Numerous agricultural and food products were subject to a plethora of
regulations, quantitative restrictions and high tariffs.3 Another area of contention
involved sanitary, quarantine, environmental and safety inspections, and other
customs clearance procedures. These served in effect as trade barriers due to the
complex and difficult bureaucratic regulations.
Another difficult area was the Korean distribution system. When foreign com-
panies wanted to enter Korea, particularly with consumer goods, one of the most
daunting issues was distribution. The Korean distribution system was complex
and underdeveloped, and the intricate logistics involved were incomprehensible
to foreign companies (Hynson 1990). Furthermore, powerful chaebols were vertically
integrated from production to retailing operations for many products, and thus
controlled distribution channels. They had their own retail agents who dealt with
their products, effectively locking out foreign products. Moreover, foreign direct
investment (FDI) was prohibited in retail industries through zoning laws and a
multitude of other regulations.

Restrictions on inward FDI

Wftiile Korea had attempted to conform to international trade rules under the
WTO, no significant progress had been made in the area of investment-related
multilateral rules. In the absence of international guidelines, Korea had developed

© Asian Studies Association of Australia 2000.

 The Korean Financial Crisis and International Business 27

a foreign direct investment (FDI) policy that discouraged and restricted inward
foreign investment in order to protect domestic strategic industries. As a result,
it was regarded as the worst of the Asian countries in which to invest (Far Eastern
Economic Review 1998a, 30). This was reflected in the low level of inward FDI in
Korea, and the fact that the amount of FDI in Korea was far below that in its
global competitors for the ten years to 1995 (Booz.Allen & Hamilton 1997, 28).
The ratio of FDI to Korea's fixed capital formation averaged only 0.9 per cent
over the six year period 1992-97, the lowest level in the world apart from Japan's
0.1 per cent. During the same period, the ratio of FDI to GDP was 0.3 per cent,
the lowest level among East Asian countries apart from Japan (Korea Economic
Weekly, 31 August 1998, 3).
Dunning (1995 and 1998) lists a number of variables which influence the
location of FDI—"location advantages". Those relevant to Korea in the 1990s
include the availability, price and quality of inputs; quality of infrastructure;
institutional competence; and government policies. The Dunning model demon-
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strates the difficulties for inward FDI in Korea. Rigidities in the factor markets in
Korea contributed to the difficulties in undertaking FDI. While a well-educated
and industrious labour force had been one of Korea's major advantages, the
labour market was not conducive to foreign business. For socio-cultural reasons,
Koreans generally preferred to work for domestic firms rather than for foreign
firms. Moreover, cultural and legal factors rendered the labour market inflexible
in the sense that laying off workers was almost impossible. Korean unions were
renowned for their militant tactics. The inflexible labour market and inefficient
labour relations raised labour costs and discouraged foreign businesses from
operating in Korea. Further difficulties arising from factor inputs emerged in
relation to land and real estate. Because of restrictive zoning laws, land and real
estate prices were extremely high, and foreigners were prohibited from purch-
asing land for business purposes. Finally, extensive government intervention and
protection of the financial sector rendered that sector inefficient, thereby raising
interest rates to higher than international levels. Korea also prevented foreign
firms not only from financing their operations from Korea but also from
providing investment consulting and trust services (Kim et al. 1998, 13).
Korean government policies discouraged and restricted inward FDI and mer-
gers and acquisitions (hereafter M&A) of Korean firms by foreign companies in
order to protect domestic firms from foreign competition (Booz.Allen & Hamilton
1997, 24; McKinsey Global Institute 1998, 18). A number of sectors were closed
to FDI by law. In particular, the financial sector was closed to inward FDI, as the
government controlled and protected that sector in order to allocate credit for
policy purposes. Even in those areas where FDI was permitted, administrative regu-
lations and processes were complex and lacked transparency. In essence, FDI was
permitted only to attract high technology investment in the form of joint ventures,

© Asian Studies Association of Australia 2000.

 28 O. Yul Kwon

although it was a fairly insignificant channel for foreign technology acquisition.

In 1991, for instance, only 6.5 per cent of Korean firms that attracted foreign tech-
nology relied on foreign investment, while the remainder utilised licensing agree-
ments or undertook technology training and reverse-engineering of imported
capital goods as away of learning foreign technology (Bishop 1997, 132).

Uneven playing field

Although the Korean market was being liberalised during this period, Korean
society remained closed. The closed nature of Korean society led to a variety of
business, legal, and institutional practices which were seen as unfair by foreign
competitors. Korea's long and turbulent history has led Koreans to become nation-
alistic, even xenophobic. They were thus apprehensive about the possibility of an
influx of foreign products and businesses. From time to time, there were public
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campaigns which advocated buying Korean products, to the ire of many for-
eigners. One of the most important facets of Korean culture is the importance
of personal relationships in daily life, as well as in business practices. Personal
relationships in Korea develop, in general, on the basis of family, school alumni,
and regionalism. This again renders foreigners in a disadvantageous position.
The nationalistic attitudes of Koreans, together with the cultural emphasis on
personal relationships, had led Korean society to remain closed, particularly from
the perspective of foreigners. In the business arena, the closed nature of Korean
society was seen as encompassing exclusionary phenomena such as networks of
Korean firms buying from each other and closed-door bidding for many types of
contracts.
The extensive state intervention in the economy over the last three decades led
to a plethora of regulations and red tape, which favoured domestic firms.4 As
Korea's laws and regulations are generally framed in such a way that they are sub-
ject to discretionary interpretation by officials, this led to the possibility of a lack
of consistency and transparency in their interpretation and application, a situation
which distinctly favoured local firms. With the high level of government interven-
tion and protection, a collusive relationship developed between the government
and business that put foreigners at a disadvantage. As a result of this collusive
relationship, business operations lacked transparency, making it difficult for
foreigners to comprehend Korean business practices.
The Korean economy was heavily concentrated in a handful of large industrial
conglomerates (chaebols), which had various advantages over incoming foreign firms.
The government initially sought to achieve its policy goals of industrialisation and
export promotion through the chaebols by providing them with a variety of incen-
tives and forms of protection. This resulted in collusion between the government

© Asian Studies Association of Australia 2000.

 The Korean Financial Crisis and International Business 29

and chaebols, and generated a perception that chaebols were "too big to fail".5 In
addition, the government provided chaebols with institutionalised privileges such
as cross-subsidiary loan guarantees, cross-subsidiary ownership, prevention of
take-overs by means of hostile M&A by domestic and foreign firms, and a lopsided
corporate governance system which favoured primary shareholders. Taking advan-
tage of these privileges and government protection, chaebols expanded and diver-
sified excessively using debt capital and dominated most industrial sectors as
monopolists or oligopolists.6 Because widely diversified operations were managed by
one family, there was a strong network among chaebol subsidiaries which enabled
them to buy from one another. These advantages, togeuier with the collusive relation-
ship between chaebols and the government, markedly disadvantaged foreigners.
There were also many restrictions and regulations that worked against foreign
businesses. Korean capital markets (stocks and bonds) remained closed to for-
eign participants until mid-1997. The government controlled and intervened in
the foreign exchange market, restricting foreigners' participation. The following
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section addresses the issue of how these difficulties in doing business in Korea
were related to the 1997 financial crisis.

INTERFACE BETWEEN THE CAUSES OF THE KOREAN

FINANCIAL CRISIS AND ITS INTERNATIONAL
BUSINESS ENVIRONMENT

Korea's international business environment, as oudined above, had an important

bearing on the 1997 financial crisis. The causes of this crisis, which have been
extensively investigated in the literature (Cha 1999; Jaw and Yi 1999; Kwon 1998;
Pyo 1999), include: (1) low productivity and loss of international competitive-
ness; (2) excessive expansion and diversification of chaebols using debt capital; (3)
the inefficient financial sector; (4) lack of transparency in business and banking
operations; and (5) an inflexible labour market. Each of these factors was related
to government intervention in and protection of domestic industries, which were
in turn the major sources of difficulties in doing business in Korea.
The difficulties foreign businesses have experienced in the Korean interna-
tional business environment have developed because of government protection
of the domestic manufacturing and agricultural sectors by means of restriction of
imports and inward FDI. As there are many cases where infant industries under
government protection have failed to mature, a paradox of domestic industry
protection has become evident in Korea. Domestic industry protection policy
typically fails because it distorts resource allocation, and protected industries
become inefficient over time. In Korea, the protection policy generated excessive
concentration of economic power in a limited number of chaebols which practised

© Asian Studies Association of Australia 2000.

 30 O. YulKwon

monopolistic business operations within the country, depriving themselves of the

opportunity to acquire international competitiveness. As McKinsey (1998) points
out, the protection policy led to slow productivity growth and eventually the
loss of national competitiveness. According to Pyo (1999), this was the key cause
of the financial crisis.7
Another cause of the difficulties in doing business in Korea was that chaebols
had various advantages over potential foreign competitors. As the government
encouraged chaebols by providing a variety of incentives (including credit allo-
cation at preferential interest rates, protection and institutionalised privileges) in
order to pursue its economic development goals, a collusive government-chaebol
relationship had developed. Taking advantage of institutionalised privileges and
government protection from international competitors and minority shareholders,
chaebols expanded and diversified with debt capital on a large scale. This was a
major cause of the financial crisis (Cha 1999; Jaw and Yi 1999; Kwon 1998),as well
as a source of unfairness to potential foreign competitors. Chaebols enjoyed enormous
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advantages over foreign businesses in raising debt capital, and controlled the
Korean distribution system through their vertical diversification, from which for-
eigners were excluded. In addition, the collusive relationship with the government
and a low standard of corporate governance led to a lack of transparency in the
operation of chaebols, which was one cause of both the financial crisis and the
difficulties experienced by foreign companies in undertaking business in Korea.
Government control and protection of the financial sector contributed not only
to the financial crisis but also to the adverse Korean business environment. In order
to control credit allocation for the purposes of its industrial policy, the Korean gov-
ernment controlled and protected financial institutions, as owner as well as regulator.
The financial sector in general (banks, securities, and foreign exchange markets)
was shielded from international competition by limiting the entry of foreign finan-
cial institutions. Even chaebols were prohibited from being controlling shareholders
of commercial banks. On numerous occasions, the government helped commercial
banks out of financial difficulties, and no major financial institution went bankrupt.
In the absence of competition, particularly from foreign financial institutions
equipped with advanced managerial know-how and risk management skills, it was
inevitable that the Korean financial sector would be inefficient. Under
government control and protection, a collusive relationship developed between
the government and the financial sector, which led the latter to lack operational
transparency, and there was a strong perception that banks would never fail. This
led the financial sector to be under-capitalised. Under-capitalisation, inefficiency
and a lack of transparency and accountability in the operation of the financial
sector were among the major causes of the financial crisis (Kwon 1998) .8
Restriction of inward FDI contributed to the crisis not only by making domestic
industries (chaebols and banks) inefficient, as discussed above, but also through its

© Asian Studies Association of Australia 2000.

 The Korean Financial Crisis and International Business 31

effect on the balance of payments. A high current account deficit was one of the
major causes of the financial crisis (Kwon 1998). Korea's current account deficit
was financed largely by capital inflows. If the current account deficit was financed
by FDI, it would not result in the accumulation of foreign debt. However, Korea
consistently maintained net outflows of FDI since 1990 (BOK 1997), because
inward FDI was discouraged at the same time as outgoing FDI expanded due to
increases in domestic factor costs. Given the rising current account deficit, the
net outflow of FDI resulted in increases in capital inflows and foreign debt, thereby
contributing to the risk of financial crisis. In addition, under the so-called managed
floating exchange rate system, the Korean currency value continued to appreciate
from 1988 to mid-1997 (Kwon 1998). The sustained appreciation of the currency
in the presence of a mounting current account deficit was a significant induce-
ment for financial speculation.
The inflexibility of the Korean labour market contributed not only to the
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adverse environment for foreign business in Korea but also to the 1997 financial
crisis. Due to government intervention and repression until the late 1980s, con-
ciliatory labour management skills were not developed. Nor did a proper work-
force retrenchment mechanism develop, because of the continuous expansion of
corporate organisations as a result of sustained rapid economic growth and
lifetime employment practices. This led to a lack of flexibility in the labour market.
The democratisation of the labour market at the end of the 1980s resulted in
militant union activity which caused labour costs to rapidly increase, and by 1995
Korea had the highest labour cost of all Asian countries with the exception of
Japan (Kwon 1998). This discouraged incoming foreign investment and led to
the loss of international competitiveness.
Excessive state intervention in the Korean economy and the resultant plethora
of regulations contributed not only to the adverse international business environ-
ment but also to the 1997 financial crisis.9 The structural dysfunction of the
Korean economy, which was reflected in the five main causes of the financial crisis,
outlined above, in essence resulted from collusion between the government,
chaebols and banks. The primary source of this collusion was government interven-
tion, repression and protection. The rules and regulations governing government
intervention lacked transparency, consistency and impartiality in interpretation
and application, thereby disadvantaging foreign enterprises.
The above analysis suggests that there was substantial interface between the
causes of the 1997 financial crisis and the adverse conditions in Korea's inter-
national business environment. The loss of international competitiveness of
domestic industries, the excessively leveraged expansion of chaebols, an inefficient
and corrupt financial sector, the lack of transparency in business and banking
operations, and the inflexible labour market were the causes of the crisis, and
were all closely related, both direcdy and indirectly, to the difficulties in doing

© Asian Studies Association of Australia 2000.

 32 O. YulKwon

business in Korea. The way in which the remedial process addresses these causes
and difficulties is examined below.

THE REMEDIAL PROCESS

Restraining aggregate demand

At the request of the Korean government, the IMF agreed in December 1997 to
provide financial assistance of $58 billion to save Korea from defaulting on its
foreign debt. However, this assistance was conditional on the implementation
of a strict policy package. The IMF policy package had three components: (1)
macroeconomic policy; (2) restructuring of the financial sector; and (3) other
structural reform measures. The objective of macroeconomic policy was to
restrain aggregate domestic demand through tight monetary and fiscal policy.
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This policy was expected to reduce the current account deficit, maintain stable
prices, attract foreign investment through high interest rates, and consequently
restore the value of the Korean currency. The macroeconomic policy also in-
cluded the maintenance of a flexible exchange rate system without state inter-
vention, and building up foreign reserves (MOFE 1997, 21). The objectives of
this macroeconomic policy have largely been achieved, in that interest rates have
come down to below pre-crisis levels, the exchange rate has been stabilised under
the flexible exchange rate system without state intervention, and foreign reserves
have accumulated beyond the agreed level (Table 1).
The restructuring of the financial sector and other structural reform measures
were both supply-side policies. Essentially, they aimed to remedy the institutional
and structural causes of the financial crisis. The assumption was that this would
improve resource allocation by increasing the efficiency, transparency, and
accountability of financial institutions and businesses, and by eliminating eco-
nomic distortions. The causes of the distortions addressed by the IMF pack-
age were numerous: price rigidity (wages and interest rates), corruption by
financial institutions, monopolistic operation of chaebols and banking institu-
tions, control of foreign exchange rates, trade restrictions, and capital account
restrictions.

Reform of the financial sector

The Korean financial crisis meant that international investors lost confidence in
the Korean economy, particularly the financial sector. Reform of the financial
sector is therefore urgently needed to enable Korea to recover from the crisis and

© Asian Studies Association of Australia 2000.

 The Korean Financial Crisis and International Business 33

Table 1: Korea's Major Economic Indicators

1996 1997 1998 1999

Qi Q2 Q3 Annual

GDP Growth (%) 6.8 5.0 -5.8 4.6 9.8 12.3 9.0'
Final consumption (%) 7.2 3.2 -8.2 5.0 7.2 8.4 n.a.
Gross fixed capital formation (%) 7.3 -2.2 -21.1 -4.3 4.9 6.9 n.a.
Exports of goods and services (%) 11.2 21.4 13.3 11.9 16.0 22.2 n.a.
Imports of goods and services (%) 14.2 3.2 -22.0 27.4 27.4 32.0 n.a.
Inflation (%) 4.9 4.5 7.5 0.7 0.6 0.7 l.F
Unemployment Rate (%) 2.0 2.6 6.8 8.4 6.6 5.8 6.92
Interest rate (%) (3-yr corp bond) 12.6 24.3 8.3 8.3 8.0 9.6 8.42
Reserve money growth (%) 2.1 -15.0 -7.2 1.0 12.1 16.2 n.a.
MCT growth (%) 21.7 15.3 7.5 5.0 6.4 7.7 n.a.
-5.2 s
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Government deficit/GDP (%) +0.3 +0.03 -4.2 -0.2 n.a. n.a.

Current a/c deficit (U$ bill) -23.0 -8.2 40.6 7.2 6.5 6.6 18.22
Foreign ex. rate (W/US$) 805 951 1399 1198 1192 1194 11822
Foreign reserves (US$ billion) 33.2 20.4 52.0 57.5 62.0 65.5 n.a.
FDI inflow (US$ billion) 3.2 7.0 8.9 2.0 2.5 4.0 15.0s
Stock price index 833 655 406 572 769 952 n.a.
Wage rate increase (%) 12.2 5.2 -3.1 8.9 13.6 n.a. n.a.
Foreign investment in Korean 3074 424 5723 1786 151 -4645 n.a.
stock (net) (billion won)4

Source: Bank of Korea 1999. Monthly Bulletin, September.

•Korea Development Institute 1999. (Korea Herald, 22 October 1999)
2
SERI1999. Korean Economic Trends, 10 July.
'Choi, Kwang 1999.
4
Korea Institute of Finance 1999.

to improve Korea's international business environment. In accordance with the

IMF policy package, the restructuring of the financial sector aimed to increase
the independence of the banking sector from the government, consolidate and
strengthen the supervision of all financial institutions, liquidate and restructure
insolvent financial institutions, and recapitalise viable institutions. This restructur-
ing also required the liberalisation of the financial sector, and allowed competition
from overseas financial institutions and M&A. At the same time, the financial
sector was required to adopt international standards regarding capital adequacy,
risk management, disclosure and auditing in order to improve the efficiency and
transparency of this sector. The government was also required to strengthen
prudential regulation of financial institutions in order to hold management
strictly responsible for their operations.

© Asian Studies Association of Australia 2000.

 34 O. YulKwon

The Korean government has been fairly successful in this respect. The new
financial bills, which were passed in December 1997, enhanced the independ-
ence of the Bank of Korea from the government, consolidated and strengthened
all of the supervisory functions of the financial sector (including banks, securities,
insurance and trust companies) under the new Financial Supervisory Commission,
and increased the Commission's independence from the government (Kwon
1998). The government closed or suspended 105 bank and non-bank financial
institutions, including five commercial banks, 16 merchant banks and two secur-
ities firms (MOFE 1999a, 11). The remaining domestic banks were recapitalised
to obtain "sound bank" status with BIS ratios ranging from 10 to 13 per cent by
September 1998 (MOFE 1998b, 29). In doing this, the government has provided
funds to purchase non-performing loans through the Korea Asset Management
Corporation (KAMCO) or to fund bank restructuring. As of March 1998, KAMCO
had purchased non-performing loans of 43.5 trillion won of an estimated total of
64 trillion won (SERI 1999a, 16-17).
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Under the new financial framework the operational efficiency as well as the
transparency and accountability of financial institutions will improve. Financial
institutions have been conducting external audits through internationally recog-
nised accounting firms, and establishing boards of directors with board members
selected by shareholders. The new financial framework introduces greater
competition into the financial sector by opening the sector to foreign capital and
allowing M&A of banks by foreign investors. Barriers against the entry of foreign
investors into the domestic financial industry have been almost entirely lifted and
capital markets have been fully opened {Korea Herald, 20 September 1999). In
particular, since the ownership of banks by foreigners was permitted with a few
nominal restrictions in March 1998, participation by foreigners in domestic banks'
equity capital has increased remarkably. As a result, the number one majority
shareholders in two banks are foreigners, and foreigners participate in the man-
agement of a further three banks (SERI, 1999b). Finally, the decision was made
in September 1999 to sell a troubled bank (Korea First Bank) to a group of American
investors (Newbridge Capital), marking a watershed in the Korean financial
sector (MOFE 1999d, 22-23).
The movement of foreign capital into the domestic financial industry not only
improves the competitiveness of the domestic financial system but also weakens
the influence of the government on the financial market. With the introduction
of advanced management skills in the areas of credit evaluation and risk control
by foreign institutions, the efficiency of the domestic financial system will be en-
hanced. As the control of major financial institutions is transferred to foreigners
with increasing foreign capital input, the government's direct intervention in the
management of financial institutions will be difficult, and the influence of the
government on the financial market will decline accordingly. This signifies an

© Asian Studies Association of Australia 2000.

 The Korean Financial Crisis and International Business 35

end to the old practice of government-controlled finance, as well as an improve-

ment in Korea's international business environment as it relates to the financial
sector.
Although substantial progress has been made in financial sector restructuring,
the basic approach to this restructuring has not been appropriate. Because of the
urgency of restoring international financiers' confidence in the Korean financial
sector, the government has stressed the speed and intensity of financial sector
restructuring. However, it has attempted to force structural reforms on financial
institutions by coercion and intervention, rather than relying on market prin-
ciples. The forced amalgamation of non-viable banks with seemingly viable ones
is a case in point. This approach amounts to an encroachment on the auton-
omy of the financial sector, and begets another type of collusion between the
government and banks, as well as raising the possibility of corruption. For the
long-term health of the financial sector after the transitional period, the gov-
ernment needs to allow the financial sector to operate according to market
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principles.

Corporate (chaebol) reform

The reforms to the financial structure, corporate governance, and transparent

operations of chaebols are a critical part of the IMF policy package, and essential
in order to improve Korea's international business environment. In the area of
corporate reform of chaebols, one of the most significant achievements thus far
has been the so-called five-point agreement between the government and chaebols
in January 1998. The agreement requires the mandatory reporting of consolidated
financial statements by chaebols, eliminating cross-subsidiary loan guarantees;
improving corporate financial structures; focusing on a limited number of core
operations; and making primary shareholders and executives more accountable
(Newsreview, 17 January 1998, 6). This agreement, once implemented, will
enhance the chaebols' operational transparency, financial soundness, corporate
governance, and concentration on areas of core competence. This will amount
to eliminating the institutionalised privileges bestowed upon chaebols and address-
ing the endemic problem of the collusive relationship between the government
and chaebols. As a result, the competitive disadvantage experienced by foreigners
in comparison to chaebols will be significandy mitigated.
In order to improve the financial and business structures, the government
ordered credit banks to assess the viability of client firms and to distinguish
between the viable and the non-viable. The non-viable firms were encouraged to
leave the market through the refusal of new credit and the prohibition of finan-
cial assistance (or fund shifting) across affiliate companies. Viable firms which

© Asian Studies Association of Australia 2000.

 36 O. YulKwon

were suffering a temporary liquidity shortage were required to formulate self-

rescue (debt reduction) plans with their credit banks; the government would
then provide some assistance in implementing these programs. The largest
five chaebols, because of their market share and economic influence, have been
coerced into taking part in so-called "big deals". These "big deals" are intended
to make the five chaebols focus on their core areas of competence, and reduce
over-capacity in nine key industries through mergers and business exchanges.
Substantial progress has been made in the reform of chaebols in accordance
with the five-point agreement. Chaebols are providing consolidated financial state-
ments beginning with the fiscal year 1999. They are expected to eliminate cross-
subsidiary debt guarantees from March 2000 and to reduce their debt-equity
ratio to 200 per cent by the end of 1999. As a way of upgrading corporate govern-
ance, listed companies (chaebols) have appointed outside directors and removed
restrictions on the voting rights of institutional investors. They also strengthened
the rights of minority shareholders by lowering the representation requirement
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for class action suits from 1.0 per cent to 0.01 per cent of total shares in May 1998
(MOFE 1998b, 34). Although this has been a major challenge, some progress has
been made in regard to the "big deals". Three "big deals" had been completed
by the middle of 1999 and the remaining six were near completion (MOFE
1999a, 12).
Foreign capital has substantially penetrated the Korean business sector. As a
way of improving their financial soundness, the five chaebols had attracted US$3.9
trillion in foreign capital as of the end of March 1999 (MOFE 1999c, 50). After
the abolition of foreign investment ceilings in domestic companies and the grant-
ing of permission for hostile M&A, the number of listed firms whose combined
foreign interests exceed that of the largest domestic shareholder increased to 42
by the end of January 1999 (Newsreview, 17 February 1999, 26). This will promote
competition between firms. As foreign companies gain more access to inside
information as shareholders, domestic firms will be further vulnerable to hostile
M&A by foreign investors.
Although substantial progress has been made in the corporate reform of
chaebols, it appears that the basic approach of the government to the task has not
been appropriate. The solution to the structural problems of chaebols should be
sought by further liberalising the market and eliminating the institutionalised
privileges enjoyed by chaebols, such as cross-guaranteeing and cross-ownership,
and the perception of a "bail out" by the government. A liberalised market will
allow foreign competition, and easier mergers and acquisitions. In the absence of
privileges for chaebols, financial institutions will lend to them only if they provide
evidence of sound business operation. This will force chaebols to concentrate on
their core areas and divest themselves of marginal operations. However, the
government has attempted to enforce structural reform on chaebols by means of

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 The Korean Financial Crisis and International Business 37

guidelines, threats, coercion and intervention, as reflected in the so-called "big

deals". Rather, it should be the companies involved in the industry—not the
government—that decide whether or not to stay in the industry, based on their
core competence and market discipline. The government's approach has caused
chaebols to drag their heels in implementing reforms, and has led them to ask the
government for financial and regulatory support. The "big deals" approach will
generate another set of monopolies in key industries, and beget further regu-
lations. Furthermore, the companies involved are under constant pressure from
the government and labour unions to minimise layoffs in conjunction with busi-
ness exchanges. Under these circumstances, the "big deals" may do little to reduce
excess capacity in the key industrial sectors—running counter to their original
objectives.

Reforms in other areas

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The IMF policy package also required trade liberalisation, capital account
liberalisation, and labour market reform, all of which have a direct bearing on
Korea's international business environment. Trade liberalisation aims to advance
the timetable of compliance with Korea's WTO commitments, including the
elimination of trade-related subsidies, trade restrictions, and streamlining of im-
port procedures. Capital account liberalisation involves opening u p the securities
market to foreign investors. Substantial progress has been made in these areas.
The government fulfilled its trade liberalisation requirements by the end of 1998
(MOFE 1998a, 27). In order to increase Korea's access to foreign capital, the
government has complied fully with the IMF requirements for capital account
liberalisation. All controls on capital movements (by both Koreans and foreigners),
including Koreans' overseas investment, borrowing, inward FDI and establish-
ment of financial institutions, have already been abolished. Foreign exchange
transactions were fully liberalised on 1 April 1999. Foreign equity ownership
ceilings have been eliminated, and foreigners are now able to invest in local
bonds and short-term money market instruments without restrictions, and to
take over Korean firms or banks by means of M&A.
The IMF policy package required labour market reforms in order to improve
the flexibility of the market, and substantial progress has been made in this area.
To comply with the IMF policy package in regard to the labour market, a Tripartite
Commission which includes labour, government and business representatives was
established, and this made it possible to revise the labour laws in February 1998.
The revised law introduced labour market flexibility by allowing layoffs for the
first time, in the event of urgent management need such as business transfers or
M&A caused by extreme financial difficulty.10 This amendment has facilitated the

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 38 O. YulKwon

necessary corporate sector restructuring and allowed firms to function more

competitively. A number of precedents demonstrating the social acceptance of
layoffs have been established (MOFE 1999a, 14), creating a new era of labour-
business culture where lifetime employment is no longer taken for granted.
In effect, the configuration of the Korean labour market has reached a watershed.
Over the three-year period from 1996-98, 65 per cent of all domestic companies
and 72 per cent of all large companies implemented a policy of downsizing. This
has changed the proportions of full-time and part-time workers. The proportion
of full-time workers declined to 57.7 per cent at the end of 1998, while that of
part-timers increased from 18.8 per cent to 42.3 per cent. In 1998, Korea experi-
enced a decline in the wage rate for the first time in history (Table 1). Due to the
downsizing of the workforce and the reduction in wages, the personnel expenses
of the 30 largest chaebols declined by 42 per cent in 1998 compared with the 1997
level (SERI 1999c, 13-20). As layoffs and workforce retrenchments have become
possible, the militancy of union tactics will be mitigated. The recent changes
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in the labour market examined above are indicative of the mitigation of union
militancy. These developments in the labour market will certainly improve Korea's
business environment in the eyes of foreigners.

Government reform

The conditions imposed by the IMF regarding structural reform of the banking
and business {chaebols) sectors and the labour market are consistent with the
causes of both the difficulties in conducting international business in Korea and
the financial crisis. The structural dysfunction of the Korean economy arose
largely as a result of collusion between the government, chaebols and banks, and
the primary source of this collusion was government intervention, repression
and protection. Hence, it is the government that needs to break the vicious circle
of collusion by eliminating its economic intervention and regulation, and leaving
the economy to develop according to market principles. Accordingly, the new
Kim Dae-jung government announced public sector reforms in the areas of
public sector efficiency, deregulation and privatisation.
Substantial progress has been made in public sector reform, although the pace
has appeared sluggish. As a way of streamlining bureaucracy and enhancing
public sector efficiency, the government significantly reduced the number of civil
servants. In 1998, the central government reduced its labour force by 5.6 per cent
or 9,084 workers, and local governments shed 12 per cent, or 35,149 of their
workers. The central government plans to reduce the number of its employees by
11.9 per cent by the end of 2001, and local governments will have 20.2 per cent
fewer employees by 2002 (MOFE 1999a, 15).

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 The Korean Financial Crisis and International Business 39

In regard to deregulation, a Regulatory Reform Committee was established in

February 1998 under the direct control of the President to undertake the task
of eliminating unnecessary or unreasonable economic and social regulations.
Within its first year of operation, the Committee abolished 5,430 regulations or
48.8 per cent of the total number. In addition, twenty-three laws were abolished
and 298 laws revised (MOFE 1999a, 15). The ongoing reforms seek to further
simplify and improve the remaining regulations, and to bring Korea's regulatory
system into line with the frameworks of the WTO and the OECD. The privatisa-
tion of public enterprises reflects the government's commitment to the market
economy and its intention to attract foreign capital. Four state-run enterprises
have already been privatised. Moreover, considerable stakes in the major public
enterprises have been sold to foreign investors (MOFE 1999a, 15). A decline in
the number of regulations and a commensurate reduction in the n u m b e r of
government employees will improve transparency and enhance the international
business environment in Korea. Foreign investors have participated in the ongoing
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privatisation of state-run enterprises.

Although the government has made substantial progress with its public sector
reform plan, it is still a long way from complete success. The reform plan requires
a further reduction in government intervention in and regulation of the private
sector and a commensurate reduction in the number of civil servants. Although
the government has announced its intention to reduce the number of civil ser-
vants in both the central and local governments by the end of 2001, the general
perception is that it will n o t achieve these reductions (MOFE 1998b, 46). The
task of privatisation is far from complete (Choi 1999). The government's basic
approach to economic problems is not appropriate. The government needs to
establish transparent regulatory rules based on market discipline and impose
them fairly and impartially. However, it is still attempting to solve economic prob-
lems, including the structural reform of banks and chaebols, through intervention,
guidance, coercion, and regulation—not through market discipline. There are
many examples of this approach. The forced amalgamation of banks and the "big
deals" policy for chaebols are but two cases in point.

Recovery prospects of the Korean economy

As anticipated, the Korean economy experienced a serious recession in 1998,

recording a 5.8 per cent contraction (Table 1). High interest rates and the credit
crunch that resulted from the tight monetary and fiscal policies during the first
half of 1998 caused consumption and investment to contract by 8.2 per cent and
21.1 per cent respectively in 1998 (Table 1). The recession continued throughout
1998, as financial institutions and chaebols pursued restructuring, thereby

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 40 O. YulKwon

generating a high level of uncertainty in the business and financial sectors. The
one bright spot in the economy was the external sector, due to the extreme
weakness of the Korean won. Since September 1998, when the government
loosened monetary and fiscal policies, interest rates have declined below the pre-
crisis level, to 8.3 per cent in 1998, compared to 12.6 per cent in 1996 (Table 1).
By the end of 1998, the financial sector was able to manage its non-performing
loans, and the credit crunch gradually eased. Low interest rates and easing credit
availability would have helped to alleviate the economic recession.
Since early 1999, the Korean economy has been rapidly recovering from the
financial crisis and the ensuing recession. According to the Korea Development
Institute, a government think-tank, the Korean economy is expected to grow by
as much as 9.0 per cent in 1999 (Table 1). Inflation is expected to decline from
7.5 per cent in 1998 to 1.1 per cent in 1999, and the unemployment rate is
expected to ease from 8.4 per cent in the first quarter of 1999 to 6.9 per cent over
the full year (Table 1). This rapid recovery can be attributed to a variety of
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factors.11 First of all, macroeconomic stability has been restored with low interest
rates and low inflation (Table 1). Korea's current account has been improving,
and foreign exchange reserves reached a record level of $64.8 billion in August
1999. As a result, the foreign exchange market has been stabilised. Secondly,
exports have continued to grow due to the depreciation of the currency, a favour-
able external environment (e.g., the booming US economy) and improved terms
of trade. Thirdly, domestic aggregate demand, including both consumption and
investment, has been stimulated by expansionary monetary and fiscal policies
(low interest rates and high fiscal deficit), as indicated in Table 1.
The successful implementation of structural reforms could be another factor
in the rapid economic recovery. The financial sector has been restructuring quite
successfully, and its stability has largely been restored. This in turn has helped the
process of restructuring the business sector. The operational transparency and
corporate governance of chaebols have largely been achieved, while the greatest
resistance to change has come from the top five chaebols, in relation to improving
their capital structure and identifying core businesses. It appears, though, that
even these five chaebols have accepted the inevitability of restructuring. The on-
going progress of banking, chaebol, and labour market reforms has helped foreign
investors to regain confidence in the Korean economy. This has resulted in increases
in inward FDI and investment in domestic stocks by foreigners. In particular,
FDI increased rapidly to $8.9 billion in 1998, a 27 per cent increase on the 1997
level and around a 3-fold increase on the 1996 level. Inward FDI is expected to
increase to $15 billion in 1999. In order to take advantage of depressed stock
prices in the absence of constraints on participation in the Korean stock market
by foreign investors, in 1998 net foreign investment in Korean stocks increased
more than 13-fold over their 1997 level (Table 1). This in turn has contributed

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 The Korean Financial Crisis and International Business 41

to a recovery in stock prices since the beginning of 1999. Rising FDI and a
recovering stock market in turn have helped to stimulate domestic aggregate
demand.
The resilience of the Korean economy has been generally acknowledged. The
national goal of economic prosperity has been reinforced by recent economic
crises. The 1997 financial crisis has proved to be a force that has united Koreans
behind a common resolution to help the economy to recover. Above all, the eco-
nomic fundamentals, including a high savings rate, well-educated workforce and
advanced production infrastructure, remain sound. These factors led to a rapid
economic recovery in 1999.
After recovering from the 1997 financial crisis, the Korean economy may not
grow in the medium term as fast as it has in the past, at 7 to 8 per cent per year,
even though it is expected to grow by 9.0 per cent in 1999. As indicated earlier,
growth potential will increase due to improvements in resource allocation through
institutional and structural reforms and deregulation.12 However, the potential
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growth rate will decline in terms of factor inputs. As the Korean economy accu-
mulates more capital, the rate of return is bound to decline, thereby reducing
investment and capital accumulation. One of the factors in the past rapid eco-
nomic growth in Korea was excessive investment by chaebols because of the per-
ceived low risk, which was in turn attributable to their collusive relationship with
the government. Under the new economic regime, collusion will decline, and
investment decisions, which had been previously taken at the central planning
office level, will be made at individual company level. These changes will moder-
ate the rate of new investment. Population growth in Korea is slowing and the
population is rapidly ageing, leading to a fall in the share of the working-age
population and pushing down the national savings rate. Educational standards in
Korea are already as high as in advanced countries (Kwon 1997), and are unlikely
to rise further. As a result, overall human capital accumulation will grow at a
moderate rate.
As the economy matures in the medium term, not only will the growth rate
slow, but the industrial structure will also change. In the past, Korea has promoted
the manufacturing sector through massive investment, and has protected it from
domestic and international competition, while it has neglected or repressed the
service sector through restrictive regulations. As the economy is further liberal-
ised and the deregulation plan is implemented, the service sector will develop
and expand relatively more quickly. In particular, the 1997 financial crisis has
taught Korea the fragility of existing industries and the importance of develop-
ing high technology and knowledge-intensive industries. Hence, the govern-
ment has highlighted the strengthening of the knowledge base as one of the
most important national tasks, as indicated in its development strategy (MOFE
1999a, 26).

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 42 O. Yul Kwon

APPRAISAL OF KOREA'S INTERNATIONAL

BUSINESS ENVIRONMENT

Liberalisation of trade, capital market and distribution system

As indicated above, the Korean economy is expected to recover and to record a
growth rate as high as 9.0 per cent in 1999. In view of the recent developments
in macroeconomic fundamentals, on-going institutional and structural reforms,
stock market recovery, and the upgrading of Korea's sovereign credit rating to
investment grade by international credit agencies (Fitch IBCA, Standard and
Poor's and Moody's) in February 1999 (KoreaFocus 1999,154), it seems likely that
the Korean economy will continue to grow at a moderate rate in the medium
term. At the same time, the nature of Korea's international business environment
will also change markedly from the pre-crisis era. Although the reform process
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has yet to be completed, most of the difficulties and challenges previously faced
by foreigners in doing business in Korea are being addressed in the process of
alleviating the financial crisis under the IMF's conditions. Korea has accepted the
IMF's demand to advance the timing of its full compliance with WTO require-
ments regarding trade liberalisation. The so-called import source diversification
program has been abandoned. In addition, Korea has liberalised capital, foreign
exchange and securities transactions.
The Korean distribution system will also change. Although there has been no
indication yet that chaebols will relinquish their control over the distribution
channels, substantial progress has been made in the distribution system. As one
of the measures to open the market, zoning restrictions relating to establishing
retail outlets have been relaxed, and foreigners can now purchase land and other
real estate for business purposes. Finally, foreign discount retailers and chains are
now permitted to enter Korea, and well-known discount retail giants have already
begun operating in Korea.13 As mass merchant discount outlets enter the market,
the Korean distribution system is bound to change.

Liberalisation of the FDI regime

Korea has been making a particular effort to attract FDI. In terms of sectoral
restrictions, most Korean business sectors apart from the financial sector were
open to inward FDI even before the financial crisis. The Korean government
has now further liberalised the remaining sectors, including the financial sector,
to the extent that 98.9 per cent of all business categories are open to foreign
participation—the remaining restricted areas being defence and cultural industries
(KOTRA 1999, 20). While Korea prohibited M&A of domestic companies by

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 The Korean Financial Crisis and International Business 43

foreigners under law and in practice prior to the financial crisis, a legal frame-
work has now been established to streamline takeovers of companies by M&A, in-
cluding hostile ones, and M&A are encouraged {Korea Economic Weekly, 23 March
1998).14
Before the 1997 financial crisis, Korea failed to take advantage of potential
location advantages in attracting FDI (Dunning 1998), largely because of restrict-
ive government policy. This problem has now been redressed. The new Foreign
Investment Promotion Act took effect on 17 November 1998, and under this Act
the policy on FDI centres on the principle of equal treatment of foreign and
domestic companies, and the emphasis of the policy has changed from "restric-
tion and control" to "promotion and assistance" (KOTRA 1999, 20). In addition,
it has introduced the so-called "one-stop" service system for incoming FDI and
placed it under the Korea Trade-Investment Agency (KOTRA). The new Act has
simplified and streamlined the complicated administrative procedures by dis-
mantling or relaxing more than 50 per cent of extant restrictions (KOTRA 1999,
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21). As a result of promotion and assistance, total FDI in 1998 reached a historic
high of US$8.9 billion, reflecting a 27 per cent increase on the 1997 level (Table 1).
For 1999, the Korean government has set a target of attracting US$15 billion
in FDI. It has unveiled its plan to increase the ratio of FDI to GDP from a low
2.6 per cent in 1996 to 13 per cent in 2003 (KOTRA 1999, 22).15

The level playing field

From the reforms of the public sector, it seems certain that government inter-
vention in the economy will diminish, and the market mechanism will be
accepted as the governing principle, in line with President Kim's dual principles
of political democracy and a market economy (MOFE 1999b, 49-54). The market
will be further liberalised and internationalised. Legal, regulatory and procedural
restrictions on accessing the Korean market will decline, facilitating access to the
Korean market for foreigners.
In the past, chaebols enjoyed various advantages over potential foreign com-
petitors, because of the institutionalised privileges bestowed on them and their
collusive relationship with the government. The on-going reforms of chaebols are
intended to eliminate these advantages. As the market is further liberalised and
inward FDI, M&A of Korean firms by foreign investors, and foreign investment in
Korean stocks increase, foreigners' stakes in major Korean firms will increase.16
Foreign companies in Korea with their ample capital, superior technology and
efficient management systems are likely to expand their managerial influence
and intervention, thereby enhancing managerial transparency and accountability.
Improved corporate transparency and accountability and the improving regulatory

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 44 O. YulKwon

environment will eliminate the sources of corruption and the collusive govern-
ment/business relationship, and make it easier for foreign firms to do business
in Korea on an equal basis.
The concentration of economic power in chaebols will subside, and they will not
be able to wield monopolistic power within the domestic market shielded from
foreign competition, as they did in the past. One of the factors in the excessive
expansion of chaebols was unfair or unlawful internal transactions and funds
transfer between subsidiaries. In 1998, the government vested the Fair Trade
Commission with the authority to trace the accounts of corporations to prevent
such internal transactions and funds transfer. Chaebols will thus be forced to dis-
card marginal companies and consolidate their operations in a limited number
of core areas. This may be reflected in the top five chaebols' agreement with the
government in December 1998 to cut their total number of subsidiaries from 264
to 130 through mergers, liquidations and absorption by the end of 1999 (MOFE
1998a, 24).
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Opening the closed society

Korean society is opening and Koreans' perception of foreigners is changing.

In the past, it was claimed that while the Korean market was quite open, Korean
society remained closed. This may reflect the apprehensive view that many
Koreans had towards foreigners and foreign business enterprises. As a result of
the financial crisis, Koreans have come to realise that foreign investment is
indispensable in the process of economic recovery, and their views and attitudes
toward foreign business are changing (Korea Herald, 9 June 1998).
One of the most important reforms Korea has achieved is the reform of the
labour laws in 1998. This reform will enhance the flexibility of the labour market,
which in turn will mitigate wage pressure on Korea's international competitive-
ness and expedite corporate restructuring. The reform of the labour laws will
lead the traditional business culture and management system in Korea to adapt
to western systems. So-called K-Type management (Lee and Yoo 1987), which
could be summarised as clan management, top-down decision making, lifetime
employment, the seniority system, paternalistic leadership and hierarchical
structure, will be difficult to maintain. With the introduction of the new labour
laws that allow firms to lay off workers, the convention of guaranteeing lifetime
employment for workers was broken. At the same time, it will be difficult for the
seniority system, hierarchical organisational structure, and patriarchal manage-
ment practices to survive under increasing international competition. As the myth
that big companies never fail has already collapsed, lifetime employment prac-
tices disappear, and job security in domestic companies declines, the preference

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 The Korean Financial Crisis and International Business 45

of Korean workers to work for domestic firms rather than foreign firms will
decline. Foreign firms will thus find it easier to recruit competent local staff.
Under these circumstances, the importance of personal relationships in business
operations will diminish. Furthermore, as foreign companies play an increasingly
important role in the Korean economy, the existing business networks will
change markedly. For their own survival, many Korean suppliers and financial
institutions will agree to be incorporated into the industrial network formed by
foreign companies.

CONCLUSION
Prior to the 1997 financial crisis, Korea was regarded as one of the most difficult
countries for foreigners to do business in. It has been concluded that the difficulties
in Korea's international business environment were in turn directly related to the
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major causes of the crisis. Hence, the process of responding to the crisis has a
direct bearing on the business climate in Korea. Korea has been undertaking a
range of institutional and structural reforms in compliance with the IMF rescue
package. Not only will these reforms, once successfully completed, make a direct
contribution to Korea's economic recovery, they will also address the difficulties
in the Korean international business environment which have been experienced
by foreigners in the past.
Korea is now at a crossroads that will determine whether it will be able to build
a renewed and dynamic economy in the next decade, or suffer the burden of a
prolonged lethargic period like the Japanese economy in the recent past. If Korea
complies faithfully and decisively with the IMF conditions, a firmer institutional
and structural foundation will be established for future economic prosperity.
Taking advantage of strong economic fundamentals such as the high savings rate,
highly educated and industrious labour force, and a powerful industrial base, the
Korean economy will recover, and the nation will emerge as an even more dyn-
amic economic power. The 1997 financial crisis will then be considered to be the
necessary price of reform and transition, and will prove to be a blessing in dis-
guise for the Korean economy. At the same time, Korea will become a synergistic
member of the international business community in the era of globalisation. If,
however, Korea does not comply with the IMF policy package, the original causes
of the financial crisis will return sooner or later, and Korea will remain an IMF
recidivist and an intransigently difficult place for foreigners to do business.
Korea has obviously taken the first route. It has been actively pursuing the
required institutional and structural reforms. The economy has been further
liberalised and internationalised. The banking sector has been reformed to a
great extent and exposed to greater foreign competition. The government is

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 46 O. YulKwon

pressing ahead forcefully with the unfinished task of restructuring chaebols and
exposing them to foreign competition. Korea has been implementing laws that
will enhance transparency and accountability in business operations. It has man-
aged to reform labour laws, thereby enhancing labour market flexibility. Under
the new labour laws, banks, chaebols and other business firms have undertaken
massive lay-offs. The government has been pursuing deregulation and eliminating
interventionist practices. These developments have all increased the confidence
of foreigners in the Korean economy, as indicated by the upgrading of Korea's
credit rating by international credit agencies at the beginning of 1999. As a result,
there are strong indications that after a one-year economic setback in 1998 with
a 5.8 per cent economic contraction, the Korean economy is recovering from the
crisis in 1999 with an expected growth rate of 9.0 per cent. Added to this is the
sanguine prospect that the economy will continue to grow at a moderate rate in
the medium term.
The financial crisis of 1997 has important implications for international busi-
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ness in Korea. Spurred on by the crisis, Korean society has worked together to
undertake massive institutional and structural reforms, even though the reform
process has been slower than anticipated due to unemployment problems and
other social and political resistance. As a result, the crisis has brought about a
different international business environment in Korea. The difficulties and chal-
lenges confronted by foreigners in doing business in Korea in the past have either
been addressed or, at the very least, reduced significantly. The Korean market is
now wide open and markedly easier to do business in than before. At the same
time, it is more competitive than ever.

NOTES
1 The author wishes to thank the two referees for their helpful comments on an earlier version
of this paper.
2Forinformation on Korea's economic success over the period from 1963 to 1996, see Kwon
(1997).
3 As a result of restrictions on agricultural imports, the prices of many food products in Korea
are much higher than the world average, and per capita spending on food as a proportion of
income is more than double that of the US, and one of the highest in the world (American
Chamber of Commerce in Korea 1999).
4 According to a poll of executives conducted by the Far Eastern Economic Review, Korea had the
highest degree of government influence over business of any Asian country (Far Eastern
Economic Review 1998b, 36). A survey of government officials, businessmen and economists
conducted by the Federation of Korean Industries indicated that 93.9 per cent believed that
Korea had more bureaucratic red tape than any other OECD country (Korea Herald, 12
November 1998).

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 The Korean Financial Crisis and International Business 47

5
Since 1972, the government has actually bailed a number of large companies out of
financial difficulties, and large-scale bankruptcy was almost non-existent until the 1997
financial crisis (Joh 1999a).
6 In 1995, the total sales of the top 30 chaebols were equivalent in value to 90 per cent of Korea's
GDP (Kwon 1997, 20), and their share of value added in the manufacturing sector was 51.3 per
cent (Hwang 1998, 61).
7 The excessive investment and diversification by chaebols resulted in low rates of return on
capital (Joh 1999b; Lee and Lee 1998).
The lack of prudential supervision of the financial sector was also an important cause of the
financial crisis, although not directly related to the adverse international business environment.
In the early 1990s, Korea's financial market was liberalised under pressure from advanced
countries, and in the absence of proper regulations, banks borrowed excessively from short-
term international capital markets—a direct cause of the financial crisis (Kwon 1998).
9Fora detailed discussion of the relationship between state intervention and the 1997 financial
crisis, see Kwon (1999).
10 The government has set up an employment stability fund to compensate dismissed workers.
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Another concession made by the government was that trade union leaders will now be given
the right to engage in political activities, and teachers will be allowed to form trade unions.
11 From their empirical studies based on a large number of countries in financial crisis, Khan
and Knight (1985) and Conway (1994) argue that it takes a few years to complete structural
reforms and help the economy recover from a financial crisis. The Korean economy is certainly
recovering faster than other crisis-inflicted countries have in the past, according to a large
number of Asian executives (Far Eastern Economic Review 1998c, 31).
12
Hwang (1998) has estimated the loss from monopolistic business practices in Korea as being
from 0.12 per cent to 2.89 per cent of GDP.
13
Well-known discount retail giants such as Wall Marts and the Price Club have already entered
Korea, and Tesco, a British retailer, is currently negotiating with Samsung Corporation to
undertake a discount retail joint venture (Korea Economic Weekly, 8 February 1999).
14 Bishop (1999) argues that in terms of sectoral restrictions, Korea is in line with general OECD
practice. With the abolition of legal barriers and the increasing information available about
Korean companies, the potential for hostile takeovers has increased markedly. Under the new
law, the compulsory open bidding system, which required the potential acquirer to openly
purchase at least 51 per cent of existing shares in the company from public shareholders, has
been abolished, and the maximum limit of shares which can be acquired without permission
from the board increased from 19 per cent to 30 per cent. Hence, hostile takeovers have, in
essence, been fully liberalised (Korea Economic Weekly, 8 February 1999, 23).
15 Bishop (1999) argues that in terms of the formalities of the approval process, Korea is a little
more liberal than Australia. According to interviews with investment executives and economic
analysts from 21 multinational firms and economic research institutes in eight countries, FDI
in Korea will easily amount to US$15 billion in 1999. The reasons behind the optimistic pre-
dictions of these interviewees included the fact that Korea's recovery was the speediest among
Asia's crisis-hit countries, the improved investment environment through the revision of relev-
ant laws, the introduction of various incentives, the sound industrial base, the quality of the
labour force and the high level of technology (Korea Economic Weekly, 25 January 1999, 5).
16 In January 1999, foreigners held major stakes in 42 blue-chip, listed Korean companies
(Newsreview, 13 February 1999).

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 48 O. YulKwon

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