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Korea's Economy

Overview

Prior to the economic crisis of 1997, Korea's impressive growth performance was part of what has been described as the East Asian miracle. The three decades of extraordinary growth that transformed Korea from one of the poorest agrarian economies to the 11th largest economy and exporting country in the world, culminated in its accession to the Organization for Economic Cooperation and Development (OECD) on December 12, 1996. Korea's rapid development was driven by very high rates of savings and investment and a strong emphasis on education, which boosted the number of young people enrolled in universities to among the highest levels in the world.

Korea's path to development, however, was full of challenges and obstacles. After its independence from Japan in 1945, Korea's economic development was a matter of national survival. With limited natural resources, insufficient domestic market, and virtually no tradition of economic development experience, Korea set out to insure its sovereignty through establishing a stable and independent economy.

However, the Korean War (1950-1953) merely prolonged the economic instability and stagnation. The number of civilian war casualties, including those missing, was approximately 1.5 million, and the nonmilitary war damage incurred to buildings, structures, equipment, facilities and other movable assets was estimated to be about US$3.1 billion at 1953 price.

The physical war damage incurred to the civilian economy was equivalent to about 85% of South Korea's 1953 GNP. During the postwar reconstruction period (1953-1960), the rate of economic growth was quite low despite the massive inflow of foreign aid. Nonetheless, between 1953 and 1995, Korea's GNP grew at an average annual rate of 7.6 %, thus resulting in about 21-fold increase in the level of GNP.

Since the population increased by 2.2 % annually during the same period, per capita GNP in real terms grew at the annual rate of 5.6 %, or increased about 9.3 times. From 1953 to 1996, Korea's gross national product increased from US$2.3 billion to US$480.2 billion, with per capita GNP rising from US$67 to US$10,543, at current prices. Over those years of rapid development, Korea's industrial structure has been drastically transformed. The economy that in the past largely depended on agriculture currently boasts a sizable manufacturing sector, which accounts for over 25.7% of Korea's GDP in 1997. The commodity trade volume reached more than US$274.9 billion in 1996, in contrast to US$477 million in 1962. The gross savings ratio rose to 34.8 % from 11.0 % during the same period. 

Seoul City Hall 

The Start of Korea's Growth in the 1960s

The journey to industrialization began in the early 1960s with the introduction of First Five-Year Economic Development Plan. It was at this point the government made a conscious policy shift from the inward-looking growth strategy of import substitution to the outward-looking growth strategy of export promotion. The essence of export promotion growth strategy was to promote exports of light manufactured goods in which Korea possessed comparative advantage given its cheap labor cost. The government utilized various macroeconomic mechanisms at its disposal in implementing this strategy, such as maintaining high interest rates to mobilize domestic savings, and enacting the Foreign Capital Promotion Act to encourage the inflow of foreign investment.

In order to promote exports, the government also devalued the currency by nearly 100 % and replaced the previous multiple exchange rate system with a unified exchange rate. It also provided short-term export financing, allowed tariff rebates on materials imported for re-export use, and simplified customs procedures. This new strategy of economic development also affected the government's view toward imports.

Realizing that it was insufficient for Korea to insist on self-sufficiency in major grains, the government allowed large quantity of grain to be imported for the first time.

The government's export promotion strategy did not receive warm acceptance at first. Conservative economists argued that such strategy would endanger national independence through excessive reliance on foreign capital. Indeed, foreign capital made up 83 % of total Korean investment in 1962, and it was not until late in the decade that Korea raised its exports enough to attain a credible debt servicing capability.

Yet, the alternatives were even less acceptable. During the 1950s, Korea had depended on grant-in-aid and concessionary public loans, mainly from the United States, which financed imports and domestic projects.

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Information provided by the Korean Embassy

Korea's Heavy and Chemical Industry Promotion in the 1970s

In the early 1970s, the changing international economic environment had a significant impact on Korea. In 1971, the Nixon Administration reduced the number of U.S. armed forces stationed in Korea by about one-third, a decision seen as the beginning of an eventual complete withdrawal of the U.S. forces from the Korea Peninsula. In response, the government resolved to develop Korea's own defense industry to a support self-sufficient military force.

Also that same year, the Bretton Woods system that had sustained stability in the international financial system collapsed. For Korea, the subsequent fluctuation in exchange rates had a damaging effect on the balance of payments. The worldwide commodity shortage of 1972-1973 and the oil shock of 1973-1974 merely compounded the problem. Korea had to respond decisively to the deteriorating trade balance by modifying its export promotion strategy. The measures undertaken by the government were to restructure the composition of commodity exports in favor of a more sophisticated, higher value-added products, to diversify its trade partners, and to increase domestic agricultural output.

To upgrade the composition of its exports, Korea turned to the heavy and chemical industry (HCI). Already an important priority in the Third Five-Year Plan (1972-1976), HCI received greater emphasis because of the changes in the external environment. With the announcement of the Heavy and Chemical Industry Development Plan in 1973, the government set forth an accelerated development schedule for technologically sophisticated industries. Investment in new industries produced significant results, and the country soon developed successful undertakings in electronics, shipbuilding, and other fields. However, the HCI drive also resulted in a number of negative effects. To initiate these industries, extensive investment in capital intensive industries had to be made, such as power generation equipment, heavy machinery, and diesel engines.

Firms that made such investments accumulated excessive debt in the process. In addition, the sharp demand for low-interest loans swelled the domestic money supply. The government's low interest rate policy to support HCI reduced savings, and producers of light manufactured goods were losing investment funds to the new industries.

As the HCI drive spread, the growing demand for skilled workers pushed up domestic wages. As a result, the wage differential between skilled and unskilled workers widened during the 1970s. Also, HCI accelerated the urbanization of Korea, as workers flocked to industrial centers where there were jobs available. In order to improve the income distribution among skilled and unskilled labor, as well as urban and rural workers, the government initiated the self-help SaemaCul Undong (New Community Movement) to improve productivity and living standards in rural areas. The government adopted grain price support program.

These programs were successful in raising crop yields and rural income and in reducing the imbalance in Koreans' standard of living. The HCI drive policy produced impressive results. Between 1972 and 1978 the GNP growth averaged 10.8 % annually, and the annual growth rate from 1976 and 1978 reached 11.2 %. The share of HCI products in total exports rose from 21.3 % in 1972 to 34.7 % in 1978. However, this progress came at the cost of high inflation.

Wholesale price increases accelerated to nearly 18 % each year from 1972 to 1979, compared to 12 % between 1962 and 1971. In addition, Korea's industrial structure was distorted by over-investment in HCI and under-investment in light industries. The government controls also distorted prices and stifled competition. At the same time, real wages were increasing faster than productivity, weakening export competitiveness. 

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Information provided by the Korean Embassy

Korea's Rationalization and Liberalization in the 1980s

By 1979, the government realized the dangers posed by these structural imbalances. Accordingly, it initiated a comprehensive stabilization program designed to control excess liquidity, realign credit priorities, eliminate price distortions, and promote competition. However, external and internal circumstances such as the second oil shock and the assassination of President Park Chung Hee in 1979 pushed the Korean economy into turmoil. Korea's economic performance in 1980 was the worst in more than 20 years as the economy contracted by 5.2 %, with the wholesale price soaring more than 38 %, and the current account deficit reaching US$5.3 billion.

To address the excess liquidity problem, the government forced firms suffering from excess capacity, namely, those involved in power-generation equipment industry and automobile industry, to merge. The power-generation equipment manufacturing industry was consolidated into the Korea Heavy Industrial Company in August 1980, the automobile industry was also ordered to specialize its production of vehicles to attain economies of scale in production. Later that year, firms producing diesel engines, heavy electrical equipment, electronic exchangers, and copper smelting were also order to specialize according to particular product lines, or be merge with others.

Between 1984-1987, further rationalization of industries took place in shipping and overseas construction. The rationalization program entailed reducing the number of firms through mergers, reducing their shipping capacity or calling off deficit-ridden overseas construction projects, and lowering tax and financial burdens in the process.

While these measures did, to some degree, reduce excess capacity in HCI, the concentration of economic power increased, since many of the troubled firms were taken over by the growing Korean conglomerates or chaebol. Moreover, the restrictions on market entry and investment further deepened a monopolistic hold on the markets for HCI products.

Such large scale restructuring of industrial firms required continuous government intervention in the credit markets. Due to the world recession following the second oil shock, many debt-ridden firms became financially insolvent. The government's concern over unemployment and financial instability led it to bail out these firms for the sake of social stability. At the same time, the government attempted to reduce the scope of intervention in the allocation of financial resources. From 1981 to 1983, commercial banks underwent privatization. The interest rate gap between policy loans and ordinary bank loans was almost completely eliminated in 1982.

Furthermore, entry barriers into the financial industry were lowered and financial services provided by different intermediaries were diversified and streamlined. The government restrictions on foreign direct investment (FDI) were relaxed substantially in recognition of the FDI's role in promoting competition and transferring advanced foreign technologies. The revision of the Foreign Capital Inducement Act in 1984 precipitated a shift to a negative system, abolishing restrictions on the foreign ownership ratio and the repatriation of capital.

Real GNP growth from 1982 to 1988 averaged 10.5 % annually, and inflation in both the wholesale and the consumer sectors was well below 5 % annually after 1982. The trade surplus began in 1986 and the amount of current account surplus reached $14.2 billion in 1988. Throughout the decade, the economy generated about 2.8 million new jobs, and the unemployment rate sank to the unprecedented level of 2.5 % in 1988. 

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Information provided by the Korean Embassy

Korea's Globalization in the 1990s

The wave of market liberalization along with the political democratization since 1987 ignited strong and violent labor disputes as well as tremendous wage hikes which have far exceeded the rise in productivity. Entering the 1990s, wage hikes averaged 18% annually. In addition to such excessive wage hikes, high financial costs, excessive administrative regulations on business activities, and low social overhead capital investment have afflicted industrial competitiveness and entrepreneurship.

Furthermore, the sudden increase in disposable income among Koreans has induced excessive private spending and speculation. The balance of payments deteriorated and inflation soared. The current account balance, which had shifted from chronic deficit to surpluses after 1986 again reverted to a deficit in 1990. Inflation reached nearly 10 % in the early 1990s.

Internationally, the 1990s witnessed growing regionalization as economic trade blocs were formed among countries of Europe and America. With the Uruguay Round, a new regime in international trade was formed that increased pressure to liberalize previously protected markets in agricultural goods and financial services. The government increasingly felt the need to change its economic strategy, as the previous strategy that promoted exports using cheap labor as comparative advantage while keeping domestic markets protected from foreign competition showed its limit.

The government began to tear old regulations apart and reform irrational procedures.

At the core of the government efforts in the early 1990s was the reform in the financial sector highlighted by the real name financial transaction system. The real name system was the government's effort to do away with corruption that was prevalent under the old system in which it had been possible to open accounts and conduct business transactions under false names, directly and indirectly fostering institutionalized corruption and illegal financial dealings.

Under the comprehensive policy theme of segyehwa (globalization), the government took an active role in participating in international economic activities through the Uruguay Round of trade talks, through it launching of the World Trade Organization, and through its membership in the Asia-Pacific Economic Cooperation. The government's effort culminated in Korea's accession to the OECD in 1996, which seemed to signal Korea's entry into the rank of advanced countries.

The Korean economy made a remarkable comeback in the first half of the 1990s. With increased investment and export, economic growth rate increased from 3% in 1992 to 8.6% and 8.9% in 1994 and 1995, respectively. The GNP per capita surpassed the US$10,000 mark in 1995, and in 1996, the unemployment rate recorded the unprecedented 2%. With such high economic growth, inflation remained relatively stable at a 4% level throughout the 1990s. 

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Information provided by the Korean Embassy

Korea's Economic Crisis of 1997

On October 1997, the Korean Stock Exchange began to plunge followed by a sharp fall of the Korean Won against dollar. Economies in Southeast Asia such as Thailand and Indonesia have already developed instabilities in their markets, to termed "crises", and the changes occurring in Korea was seen as a part of a regional contagion effect deriving from the Southeast Asian crisis. However, by November 21, Korea's foreign reserves were nearly depleted, and to prevent the total collapse of the economy, the government announced that it would seek emergency loan from the International Monetary Fund (IMF) to overcome the difficulties in the financial and currency markets.

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Causes of the Economic Crisis

Throughout the 1990s, the structure of the Korean economy has become increasingly vulnerable to unfavorable shocks. The vulnerability came from two sources. First was the overly short-term oriented external debt structure and insufficient foreign exchange reserves. Korea's external debt to GDP ratio has been rising rapidly and continuously since 1994 as comprehensive financial deregulation proceeded. Rapid increases in private sector borrowings including both direct borrowings of corporations and bank borrowings to finance the corporate investment, accounted for most of the external debt increase.

While the external debt to GDP ratio reached approximately 25%, not an unsustainable level given Korea's economic growth potential, the rapid increase of short-term debt and the term-mismatches were clearly signs of possible external liquidity problems. By the end of 1996, the share of short-term debt out of the total external debt peaked at 58 %, while the foreign exchange reserve remained low.

The second factor behind Korea's economic vulnerability was the highly leveraged corporate financial structure. The corporate debt relative to nominal GDP ratio was lowest in 1987-1988 when Korea enjoyed current account surpluses. However, since then, the ratio increased substantially to reach over 1.6 in 1996. Due to the highly leveraged financial structure, largely driven by the over-investments of Korean conglomerates, chaebol, the corporate sector has become increasingly vulnerable to unfavorable shocks.

Such deficiencies in Korea's economic structure were the legacies of its past development process. The 30 years of government-led growth process created a close and collusive relationship between the government and chaebol. Chaebol often engaged in projects at the government's bidding and the government, in turn, implicitly provided insurance against project failures. The society as a whole came to accept the so-called "too-big-to-fail" expectation. Under such a belief, the business firm's main concern became expansion in size rather than to earn profits. To finance the expansion of businesses, firms chose the option of debt-financed growth rather than equity-financed growth. The high debt-equity ratio that resulted from such strategy exceeded 400 % by the end of 1997, and the average ratio for the 30 largest chaebol reached 518 %. These figures are approximately twice the rate of Mexican firms and four times the rate of Thai firms at the time of their crises.

Unfavorable terms of trade shocks in 1996 severely damaged profits of Korean corporations in 1997. Series of corporate bankruptcies, even among the major chaebols, including Hanbo, Kia and Yuwon, increased the size of outstanding non-performing bank loans at an astounding speed. The deterioration of the corporate sector translated into the weakening of the financial sector. The stringent lending policies adopted by financial institutions in an attempt to minimize the effects of a worsening economic situation, resulted in the shortage of capital which futher increased the number of bankruptcies.

Responding to the precarious economic situation, the government launched the Presidential Commission for Financial Reform to begin a comprehensive reform of the financial market. In the labor market, a separate Labor Reform Commission was launched in early 1997. But such early actions taken to prevent further economic deterioration failed due to several reasons. First, conflicts soon surfaced as the Presidential Commission for Financial Reform and the Labor Reform Commission began implementing sectoral reform measures.

At the time, the administration of President Kim Young Sam, who was also nearing the end of his term in office, could not provide necessary leadership to aid those reform efforts. Second, the government's unwarranted heavy-handed actions taken subsequent to the bankruptcies of Hanbo and Kia disappointed foreign investors. Finally, the Ministry of Finance and Economy's inadequate handling of the developing foreign exchange crisis finally brought in a bailout fund from the IMF.

In other words, insolvent corporations and financial institutions damaged Korea's credibility abroad, leading to foreign capital flight. The vicious cycle of foreign exchange shortage and deterioration of Korea's credibility developed into a full-fledged foreign exchange crisis at the end of 1997. 

Challenges and Opportunities in Korea

Over the six months since the Korean government and the IMF agreed on the provisions of the IMF standby loans in December 1997, the Korean government implemented countless reform measures to stabilize the situation. The government persuaded labor union leaders and the general public to share the burden of economic restructuring by forming a high-profile body, the Tripartite Committee, consisting of labor leaders, business leaders, and public officials. The committee produced an agreement, the Tripartite Accord, containing 90 detailed measures that constitute the basic principles of the economic restructuring process. On April 1998, US$21.8 billion worth of domestic banks' short-term external debt was converted to long-term government-guaranteed debt. In that same month, the Korean government successfully launched its inaugural global bond totaling US$4 billion. These factors, together with Korea's improved current account balance, raised usable foreign reserves from US$8.9 billion at the end of December 1997 to US$41.4 billion as of August 1998. The Won-dollar exchange rate has stabilized around 1,300 Won per dollar.

The government is responding decisively and with deft leadership skills to the crisis at hand. Covering a wide spectrum of economic structural reforms, in finance, corporate governance, labor, liberalization, and the public sector, the following measures are currently implemented. 

Financial Sector Reform

In observance of the agreement reached between the Korean government and the IMF, the economic reform program being pursued focuses on macroeconomic stability and overall reform of the Korean economy. The macroeconomic policy aims to achieve stabilization by requiring acquisition of sufficient foreign reserves, reforming the corporate and the financial sectors, and laying a foundation for enhancing the country's long-term growth potential.

The Bank of Korea maintained a tight monetary policy stance since 1997, reflected in the market interest rate hike that at one point reached as high as 20%. In the public sector, a stringent government budget is being implemented with a 3.8% growth rate, which is lower than the nominal GDP growth. The organization and staff of government agencies are being reorganized and paired down while local government budgets are being reduced.

To reform the ailing financial sector and to restore public confidence in the system, resolution of unsound financial institutions is being pursued as a top reform priority.

The Korea First Bank and the Seoul Bank, whose deteriorated capital adequacy ratios resulted from mismanagement, were recapitalized by the government with the stocks of public enterprises. The government's share of these two banks will soon be sold off by open bidding to domestic or foreign investors. The other 12 banks that failed to meet the BIS capital adequacy ratios have submitted rehabilitation plans to the Financial Supervisory Commission (FSC). Thorough evaluation is being conducted and an appropriate restructuring of the entire financial sector will take place involving acquisition, merger, or purchase and assumption.

As for merchant banking corporations, 14 of them have been shut down with two others ordered to suspend all activities. The remaining 14 merchant banks are ordered to clear off bad loans through an increase in equity capital or be shut down. The licenses of two security companies and one investment trust company have been revoked, and investigations are now underway to evaluate the management status of non-bank financial institutions, such as leasing and life insurance companies.

The Non-performing Asset Resolution Fund, set up in November 1997 to clear bad loans from the books of financial institutions, has already bought bad loans with a book-value of 16 trillion Won. Furthermore, financial supervision has been strengthened through improved supervisory system and raised standards of prudential regulation. In April 1998, the Financial Supervisory Commission (FSC) was launched to integrate supervisory mechanisms over banking, securities, and insurance industries. In an attempt to enhance the transparency in the financial sector, statistics on non-performing loans of banks, including substandard loans, are now released every six months.

Prudential standards were made stricter by requiring financial institutions to set aside provisions of 100% loan losses and securities valuation losses. Meanwhile, in order to resolve the problem of financial insolvency as it applies to depositors, the coverage of deposit protection is scheduled to be narrowed. In November, the government announced that the principal and interest on all types of deposits at financial institutions would be insured in full, for an interim period up until the end of year 2000, in order to prevent bank-runs.

From August 1998, however, only the principal will be guaranteed in the case of deposits exceeding 20 million Won per person. For deposits of less than 20 million Won, payment of the principal and interest at the average rate for time deposits with commercial banks will be guaranteed. 

Corporate Sector Reform

The ongoing corporate sector reforms aim to achieve two objectives. First, it aims to reduce the size of corporate debt, and second, it aims to institute a new corporate governance structure that will induce better and more transparent management. Unlike in the past, the government will not intervene directly in the restructuring of the corporate sector. Instead, the government will focus only on improving the legal and institutional environment to facilitate and monitor the process. The government will support the financial sector to expedite its restructuring efforts by providing funds for recapitalization and liquidate all non-performing bonds. Financial restructuring will help the corporate sector reform by easing liquidity constraints and enhancing the monitoring mechanism.

In Korea, the 30 largest chaebol account for about one-third of total value added and in addition to fixed assets in the manufacturing sector. Although chaebol were the primary engine of economic development in the past, it is also true that their highly leveraged financial structure and unprofitable expansion made the entire economy very vulnerable to the economic downfall. Moreover, because chaebol business activities are diverse, and because they are sector leaders, their economic influence is even greater than their sheer size.

Nonetheless, chaebol have voluntarily announced their willingness to undergo a restructuring scheme that will allow each chaebol to concentrate on core businesses, implement a sound balance sheet and transparent management, and improve governance structure. Chaebol managers will be made responsible for their investment choices, and business practices. The government has made it clear its intention to no longer favor large businesses in providing various forms of assistance. Instead, small and medium-sized firms will be nurtured and protected from unfair competition practices from the large sized competitors.

In order to enhance the reliability of corporate financial statements, the FSC has set new accounting and auditing rules in line with internationally accepted standards. In addition, all listed companies are now required to establish a committee of external auditors. Upon implementation of these new guidelines, the quality and reliability of key financial information provided by banks and corporations will be improved, thus providing regulators, shareholders, and the general public with a more credible basis for performance evaluation.

Legal protection for the rights of minority shareholders has also been strengthened. The representation requirement for derivative suits against managerial abuse has been reduced from 1 % to 0.01 %. The revised Security Exchange Act also allows any shareholder with at least 0.5 % (previously 1 %) ownership the right to ask the firms to dismiss a director or an auditor, and with 1 % ownership (previously 3 %) to review financial accounts of the firm.

Additional measures to improve corporate governance include amending the Commercial Law to simplify M&A procedures, shortening the appeal period for mergers from two months to one month, introducing a de facto directors system, implementing a cumulative voting system, and bestowing voting rights to institutional investors whom previously have not been allowed to vote. 

Corporate Restructuring

The fierce competition among chaebol to boost productivity led them to set up subsidiaries and investing in diverse lines of manufacturing where profitability was high. However, as prices have fallen due to oversupply around the world since the mid-1990s, the financial structures of the companies have deteriorated badly. The problem became worse as domestic demand fell due to business stagnation at home and investments were excessive and overlapping. As a result, corporate restructuring became necessary because the over-extended and overlapping lines of businesses among chaebol have become an obstacle to economic recovery.

First, big corporations led by Hyundai, Samsung, Daewoo, LG and SK groups have agreed to realign their lines of business in seven areas-semiconductors, petrochemicals, automobiles, aircraft, rolling-stock, electric generating facilities, ship engines and petroleum refining.

The gist of their agreement calls for efforts to merge companies in the same line of business to reduce the number of companies in each field. At the same time, they plan to push for investment by foreigners in their business. Thus, they hope to reduce unnecessary investment, raise competitiveness and promote foreign investment. 

Labor Market Liberalization

The labor market environment in Korea in the past has been characterized as "rigid." The legal system awarded workers substantial job security by limiting redundancy layoffs and temporary labor contracts. The conditions and procedures of redundancy layoffs, which were not clear, in many ways placed an obstacle to flexible market adjustment, as economic growth slowed in the 1990s, and also as the economy shifted emphasis from quantitative expansion to qualitative enhancement with greater emphasis on knowledge-intensive and high-tech industries. The need for sectoral reallocation and downsizing increased, but businesses often found their ability to do so greatly restricted.

Liberalized union activity since 1987 has increased rigidity in the economy. In the late 1980s, the government failed to control the illegal practices of unions, sometimes resorting to selective intervention for political gains. Furthermore, market forces could not discipline industrial relations in large firms and chaebol, as most people in Korea believed that large firms will never go bankrupt. The "too-big-to-fail" expectation stemmed from a series of past industrial policies favoring large firms.

In particular, enterprise unions in chaebol became stronger and more militant, and dismissals became virtually impossible. The economic crisis of 1997 provided an opportunity to enhance labor market flexibility and restore market mechanisms. It is understood that there is a need for a more flexible labor market in which labor allocation and wage determination are efficiently governed through market mechanisms. The government has made several announcements stating that while unlawful layoffs will not be tolerated, economic restructuring will take precedence over job security. In February of 1998, the government passed legislation legalizing redundancy layoffs, and also relaxed the previously restrictive legal provision relating to manpower leasing services. Firms now facing labor demand can adjust employment more flexibly and at a considerably lower cost, a major step toward economic recovery.

To form a consensus on labor-related issues, the Tripartite Committee was formed among the representatives of labor, business, and government. The committee established rules for an equitable sharing of both economic and noneconomic costs, and attained public consensus for the restructuring. The committee accomplished an accord which contained a considerable number of measures to enhance corporate governance transparency, and to increase unemployment benefits and labor market flexibility.

In addition to improving efficiency through increased flexibility, the Korean government is also addressing equity and social issues. Unemployment rates increased from 2.6 % in November 1997 to 7.6 % in July 1998, and is expected to increase further. The rates are a source of concern for the government which aims to reduce unemployment in order to insure social stability.

Public Sector Reform

In the process of structural reform of the Korean economy, successful fiscal and public sector reform is crucial. A well-managed public sector is seen as an essential factor in leading the whole reform process, by setting a good example on the one hand, and by effectively allocating limited financial resources for the adjustment process on the other. Budget deficits are unavoidable during the first few years of restructuring and it will be difficult to provide justification of higher tax burdens to the people without showing that comprehensive reforms in the public sector are also being undertaken.

The public sector in Korea has been long criticized for its inefficiency and lack of transparency. It is recognized that competition, market forces, and corporate style management strategies are needed to enhance efficiency and transparency, and to improve the quality of administrative services. In the area of government budgeting, it is well-known that, in the past, the government has maintained a sound fiscal stance in spite of the relatively low overall tax burden ratio. The national debt-GNP ratio in 1996 was just 9.5 %. However, there are still many things to be done to increase value for money. The budget structure must be changed to cut the portion of nondiscretionary expenditure. There are also efficiency problems in government spending on agriculture, education, and infrastructure. Some investment programs were initiated without the appropriate and rigorous cost-benefit analysis.

It is very important to improve the overall budgeting system to enhance transparency and accountability and to reinforce the macroeconomic stabilization function of fiscal policies. The public sector reform was deemed necessary to meet the fiscal demand of the public and to finance the costs of structural adjustments while keeping a sound fiscal stance in the long run.

Recognizing this, the Korean government has started to reform the budgetary and public sector. Initial restructuring of the central government organization began in February of 1998. To initiate the process of public sector reform, the Government Reform Office in the Planning and Budget Commission was launched. A plan for reducing the number of civil servants by approximately 10 % was announced. Five ministries were eliminated out of the total number of 22. State-owned enterprises and other government-funded institutes are being thoroughly examined and will be streamlined to minimize government subsidies and to increase efficiency.

The range of direct government intervention will be reduced, and market competition in the public sector will be more widely introduced through self-discipline and privatization. The public sector will, in the long run, become a corporation financed by taxpayers. Customer-oriented administrative services will be provided with restructured incentive systems for public employees and a widely adopted practice of outsourcing.

Korea's tax system will be streamlined in order to increase transparency in line with international standards and the number of tax items will be reduced by consolidating many earmarked surtaxes and abolishing ineffective tax items. The income tax base will need to be broadened and more property taxes will be imposed. 

Opportunities for Further Growth

Korea's economy now stands at an important crossroad as it faces new challenges.

The future path of the country depends upon how prudently the political leaders, the government, the business leaders, workers, and the public manage the current economic crisis. Current account surplus has been maintained since November 1997 with the help of increased exports and decreased domestic demand. The foreign exchange rate has stabilized at near precrisis level and the stock price index has recovered from its lows due to the resumption of foreign capital influx. At the same time, series of liberalization measures are starting to take effect, especially in the corporate sector.

There has been active M&A activities between foreign and Korean firms, and foreign participation in the Korean bond market has increased. It is important to keep in mind that these reform process did not begin with the breakout of the 1997 financial crisis. Instead, they were already in the process of being implemented under Kim Young Sam's globalization policy, examplified by South Korea's membership in the OECD. Therefore, the consensus for reform has existed in minds of Korean people. Furthermore, the election of the President from an opposition party created an adequate political environment to implement change, allowing reforms to take place at faster pace.

With sound infrastructure for market economy in place, Korea will once again become the economic center of Northeast Asia, with ample opportunities for investment. Korea's rich human resources, history of miraculous development, and unyielding commitment to liberal democracy all attest to its potential to recreate a robust economy in the decades to come.

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