Monday, August 01, 2011

IMF Bailout of Korea During East Asian Financial Crisis (Part III)

[Series Index]


Part III continues Wangkon936's discussion about IMF's bailout of Korea in 1997. In Part IV, the Korean will discuss the social reaction to the bailout.


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After the East Asian Economic Crisis

So, at the 10th anniversary of the crisis in 2008, many asked if Asia was better off after IMF involvement.  Yes and no.  Countries like Thailand may have regressed.  Although the IMF itself will say that Thai banks and regulatory controls are stronger than they have ever been, the Thai economy's average GDP growth rate of 7-8% has not fully recovered.  Real GDP per capita, after adjusting for inflation, has seen little improvement as well from 1996 highs.  Korea has done better, and in part this was due to the IMF mandated reforms.  Admittedly, some reforms were instituted as a direct and indirect result of the IMF's transformative conditions they had placed on Korea in 1997.  One can even argue that the IMF induced reforms didn't do enough, if one is to think that Korea's export led, high capital expenditure conglomerate oriented strategy is not a long term solution to its growth. 

Overall, the region has more stable regional macroeconomic policies, particularly through the accumulation of substantial foreign reserves.  Gone are the days where Korea's foreign reserves were just a dubious $25 billion.  They are now more than ten times that size.  Second, the transparency of policies has increased, as reflected in the routine disclosure of external debt and reserve information by Asian authorities.  Third, corporate governance has improved through the reform of regulatory and supervisory systems.

However, the IMF's methodology of using aspects of “shock therapy” as part of their prescription has alienated many of the poorer and middle income economies.  A good example is Latin America.  As mentioned before, the IMF did not have a good reputation within the region when it provided help to Argentina in 1991.  So, when Argentina decided to pay off its last remaining $9.8 billion to the IMF in 2006, Venezuela committed $2.5 billion to that total. Thus, Argentina found an alternative source to help fulfill their obligations to the IMF.  Now six Latin American countries, including Argentina and Venezuela have formed a new lending institution called the "Bank of the South." Although many details remain to be worked out, when one looks at the rhetoric surrounding the establishment of the bank, the intention is clearly to form an alternative to the IMF, particularly when they need a lender of last resort.

(More after the jump)

Got a question or a comment for the Korean? Email away at askakorean@gmail.com.



Within Asia too there is a nascent belief that perhaps the region needs it's own lender of last resort as well.  The Asian countries took steps in this direction by establishing a regional stabilization fund with the Chiang Mai Initiative that began in 2000. This includes a collection of bilateral currency swap arrangements among the ASEAN countries plus China, Japan, and South Korea. Under these arrangements, these countries would be able to access at least some foreign exchange reserves in the event of a liquidity or currency devaluation crisis of the type that was experienced in 1997. Although the initiative is still tied to the IMF when a country needs to swap a very large amount of currency, many economists believe that it will further weaken the region's link to the IMF.  So far, the thirteen Asian countries agreed, in principle, to pool part of their over $3 trillion of reserves for a stabilization fund.  These currency swap arrangements helped Korea avoid being a full participant of the “Great Recession” of 2008.

What's Next for the IMF?

The sum of all this is that organizations like the IMF (and the World Bank) are losing relevance and influence internationally.  However, institutions like the IMF have a lot to offer the rest of the world.  Regional and global economic and financial crisis need international cooperation to limit their scope and severity and prevent wider contagion.  Furthermore, the IMF, built upon Western institutions, traditions, economic philosophies, etc. have the potential to spread more sophisticated economic and financial best practices to developing countries and that could be conducive to more transparent governments, pluralistic societies, the spread of democratic ideals and sustainable economic growth rates, particularly when a country is moving towards a knowledge-based economy.  Many economists and policy makers still believe this to be true, despite the mistake that were made by Western institutions in creating the subprime crisis in 2008. 

The Bank of the South in Latin America, that is seeking to replace some functions of IMF, has been established by left leaning governments of that region (particularly Uruguay, Paraguay, Ecuador, and especially Venezuela).  It is especially telling that the headquarters of the Bank of the South will be in the capital of Venezuela, Caracas.  Furthermore, President Hugo Ch├ívez of Venezuela has been its most vocal supporter.  It's unclear what the future will bring, but many believe that this will likely mean a situation where Latin American countries may find it easier to shift more to the left to policies that are less capitalistic and more socialistic in nature.  It may also mean a shift away from Latin American interest in Western institutions and development models, particularly among the poorer countries of that region. 

The IMF was established with well-meaning ideals after difficult lessons learned from the Great Depression and the tremendous amount of rebuilding required after WWII.  However, the way it has pursued its policies and given help to developing countries have alienated many of the regions and nations they have professed to help.  This has hurt their ultimate mandate of being the go to authoritative institution to provide economic and financial stability, particularly to nations that can't defend themselves in times of economic difficulty.

The good news is that it appears the IMF is not oblivious to the harsh feelings and memories in the countries they have helped.  Even the IMF would say it would have done things differently in both Asia and Latin America.   For example, back in 1997, the IMF criticized Malaysia for pegging its currency to the U.S. dollar to protect it from currency speculators, but now it is generally viewed as a wise decision.  With Korea, it has also been admitted that their recommendation to tighten credit and raise interest rates was not the right move either.  Yet, for the larger question of what the IMF did in Korea was “fair” or “unfair” is more difficult to answer and open to interpretation.  The majority of knowledgeable analysts would say that the IMF's handling of preventing and responding to the unfolding crisis in Korea (and elsewhere) was not efficient and suboptimal.  The IMF has clearly taken some of those lessons and applied them in Russia in 1998 and Spain and Greece in 2010.  However, it is the belief of this author that Korea was not a completely innocent party to it's own economic difficulties, given it's fondness of overloading on debt to fuel growth.

The world has changed quite a bit since 1997.  There is more globalized trade and many of the countries that were squarely in the “developing” camp are moving to become wealthier nations, rivaling what was considered G-7 countries 15 years ago.  Nations like Brazil in Latin America and both China and India in Asia are becoming more influential in the world economy.  Together with Russia, they form the so-called BRIC countries and now have 14.2% voting power in the IMF, close to the 15% necessary to exercise a veto.  Even a middle sized country like Korea, now a G-20 nation, is the 16th largest voting power in the IMF.  At the very least, Korea could be an important swing voter in the IMF.  Thus, today Korea is not a country the IMF can easily dictate terms to if it ever needs the organization's help again. 

Understanding the increased importance of Korea in the region, in July 2010 the IMF co-hosted a conference in Korea a few months before the G-20 summit that was also to be held in said country.  In the conference the IMF admitted that they had made mistakes in Korea, and elsewhere, and looked to mend fences.  Although they said that difficult choices had to be made and they had to be made quickly in an unfolding economic crisis, in hindsight it was possible to do so without forcing so much austerity to the general population.  However, forgiveness does not come easy, especially in a nation like Korea.  That will be the subject of part IV.

Got a question or a comment for the Korean? Email away at askakorean@gmail.com.

21 comments:

  1. However, it is the belief of this author that Korea was not a completely innocent party to it's own economic difficulties, given it's fondness of overloading on debt to fuel growth.

    How does the word "innocent" even enter the conversation when it comes to Korean responsibility for their own financial stability?

    They were 100% guilty, despite numerous attempts to lay the blame at the foot of the IMF.

    As for any questions of "fair" or "unfair," who cares? When you've sunk to the point that you have to go begging to the IMF, you take whatever you can get, and you shut the hell up while doing so, because the IMF is a last resort.

    And when you're sitting at the door of your last resort, you can't dictate terms, you can't cry about fair or unfair, you simply take whatever medicine they're generous enough to give you, and you better be thankful for it, no matter how inefficient or suboptimal.

    You leverage determines your ability to bargain or place blame, and Korea had none at the time, so it's largely irrelevant what the "local needs" were, because beggars can't be choosers and they certainly don't dictate terms or have any say in the details of the loans.

    In fact, if Korea Inc were so intelligent about the local needs and special circumstances of their situation, they wouldn't have been in the situation in the first place. So it was absolutely reasonable for the IMF to completely disregard the advice of the very people that ran the ship into the ground when trying to set a new course.

    That's part of the reality when you've hit rock bottom. Inherent in the circumstances of being a beggar is that fact that you've given up your rights to have any significant say going forward. And that's exactly as it should be, otherwise the IMF would just be an easy bailout for risk-loving countries.

    The IMF makes for a good boogeyman and external source of blame for politicians desperate for scapegoats and butthurt nationalists, but no one outside of Korea should take any of it seriously.

    It's like going to a loan shark and then crying about the 50% vig. If banks turn you away and you've got no other alternative, live with your choices and be glad for whatever you can get.

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  2. It's like going to a loan shark and then crying about the 50% vig.

    Most civilized countries have usury laws against such measures.

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  3. The kind of loan sharks I'm referring to have as much interest in usury law as they do in IRS regulations. Which is to say none.

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  4. I don't know much about this issue but isn't it true that the era of Korea's phenomenal economic growth came to an end with the IMF crisis?

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  5. The kind of loan sharks I'm referring to have as much interest in usury law as they do in IRS regulations. Which is to say none.

    So you're saying it is perfectly fine for IMF to act like lawless thugs?

    I don't know much about this issue but isn't it true that the era of Korea's phenomenal economic growth came to an end with the IMF crisis?

    Depends on how you define "phenomenal."

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  6. Well, I'm not sure if Mr. Computer Generated URL Fragment read the other two parts of the series (or even part 3). It goes into depth of the advantages and disadvantages that developing countries have when working with developed countries in matters of economics and finance.

    His attitude doesn't help though. Korea, with all it's problems, must still be considered a developmental success story. I can probably count on one hand the number of major non-Western nations that have successfully reached developed status since the end of WWII. That in itself is a terrible record. However, Mr. URL Fragment's attitude is probably why that's the case. Our way or the highway, etc. No wonder Communism was so appealing after WWII, due to that callus attitude.

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  7. Matt,
    It would've been impossible for SK to maintain the growth rate as it matured anyways.

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  8. "It would've been impossible for SK to maintain the growth rate as it matured anyways."

    I fully agree.

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  9. So you're saying it is perfectly fine for IMF to act like lawless thugs?

    That's not what I was saying, but my actual opinion isn't far from that. The analogy was between similar situations in which a country/individual had buried themselves to the point that they had exhausted all avenues of legitimate and reasonable help, and had been forced to rely on an entity which has unilateral power over them, and whose terms are far worse than traditional financing institutions.

    I personally believe that the IMF should impose extremely strict and harsh terms in their rescue packages, even when not necessary or required by the economic situation.

    The purpose should be to force the receiver countries to take extraordinary and painful measures, and there should be a punitive element as well. That would serve as a deterrent for future recklessness and irresponsible behavior from the receivers as well as other countries that may see the IMF as an easy bailout.

    Countries should come away from an IMF experience having endured significant hardship and pain, to the point that they never want to see the tie of an IMF official again.

    If you look at Korea's foreign currency reserves and see the laser focus that they now monitor and bolster them, it appears the IMF accomplished that goal.

    The backlash and blaming of the IMF within Korea was largely a function of wounded pride and scapegoating.

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  10. Why is the IMF not a "legitimate and reasonable help"? Why is IMF not more like the Federal Reserve of the United States, but more like a thuggish usurer? What makes IMF illegitimate, and why must it be unreasonable?

    Here is an analogy. Smoking unmistakably contributes to pneumonia. So suppose a smoker comes to the doctor with a case of acute pneumonia. Should the doctor then take out a lung, "even when not necessary or required by the" patient's health situation, just to punish the patient for smoking?

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  11. Mr. Broken URL,

    The conditions you describe above also describes the U.S. Subprime Crisis of 2008. If the U.S. didn't have the internal wherewithal to solve its problems and had to rely on the IMF, do you believe the U.S. should have been forced to go through similar austerity measures?

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  12. "Legitimate" was the wrong choice of word. Should have been "traditional," because the IMF is certainly legitimate.

    Regarding your question, I've already outlined why it should be unreasonable: Because its purpose is for last resort, emergency situations in which the regular avenues of financing have all been exhausted and the country in question is considered too great of a risk for profit-loving banks. The more "reasonable" the IMF gets, the more it is simply an international bank financed by rich countries which bails out irresonsible, reckless nations and rewards them for failing to manage their risks properly.

    The IMF is made of donor countries who are in direct economic competition with the countries they provide bailouts to, and that is reason enough to demand austerity, harsh restrictions, and painful restructuring as condition for the loans. It would in fact be self-defeating for donor countries to run the IMF like a traditional bank and provide bailouts with non-restrictive terms.

    The goal of the IMF is to provide for the stability of the world economic system by preventing defaults and collapses which could by contagion impact the rest of the world. Donor countries are in fact assuming risk by doling out loans to receiver countries who have proven to be incapable of managing their own economies responsibly, and the price for taking on that risk should be high. If that price is not high and painful, it simply encourages high-risk/high-reward behavior, and that behavior is contradictory to the stability that the IMF has as its goal.

    If Korea (or other countries high on charity) believe otherwise, perhaps they can start their own version of the IMF and hand out hundreds of billions with low interest and no conditions attached to their economic competitors. Ever wonder why that doesn't occur?

    And your doctor analogy is completely off base and inapplicable. A doctor treating a patient is an economic exchange of payment for service. The doctor has no vested interest in punitive retribution against the patient because he is not in competition with that patient. In fact, the continued smoking of the patient actually benefits the doctor in economic terms, and there is absolutely no risk borne by the doctor in treating the patient either.

    That's not even apples and oranges. It's apples and wrenches.

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  13. Edward, absolutely 100% yes. Luckily for the US, our reputation and history of economic responsibility and strength allowed us to avoid that scenario.

    That reputation is now taking a significant hit, so perhaps we won't be so lucky in the future.

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  14. If Korea (or other countries high on charity) believe otherwise, perhaps they can start their own version of the IMF and hand out hundreds of billions with low interest and no conditions attached to their economic competitors. Ever wonder why that doesn't occur?

    Did you even read the post? It clearly states that there already alternative versions of IMF. So, ever wonder why that does occur?

    A doctor treating a patient is an economic exchange of payment for service. The doctor has no vested interest in punitive retribution against the patient because he is not in competition with that patient. In fact, the continued smoking of the patient actually benefits the doctor in economic terms, and there is absolutely no risk borne by the doctor in treating the patient either.

    Ok, let's modify it a tad. Suppose we live in Great Britain, where medicine is socialized. Everyone pays into the National Health Services, and everyone is treated out of the NHS. The doctor -- or more precisely, the NHS that moves the hand of the doctor -- now has plenty of incentives to stop a patient from smoking. It will place less burden on the doctor's payment into the NHS, and it will also free the doctor from having to attend a pneumonia patient who partially brought it upon himself. (This is about the same as the risk that IMF members bear for a bailout.)

    In this scenario, how do you feel about taking out a lung, "even when not necessary or required"?

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  15. "Luckily for the US, our reputation and history of economic responsibility and strength allowed us to avoid that scenario."

    I guess you can say that. Essentially, we were lucky that enough Europeans and Chinese saw enough value in the dollar that the Fed could print like crazy.

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  16. Did you even read the post? It clearly states that there already alternative versions of IMF. So, ever wonder why that does occur?

    The Bank of the South mentioned is certainly a positive development, as regional funding sources are far preferrable than a world authority, but let's not pretend it is anything near in stature, strength, or potential effectiveness to the IMF. If you didn't notice, I specifically said "hundreds of billions" in my question because that kind of capital is what's required for rescuing large economies, numerous small ones, or dealing with a worldwide collapse.

    Not only that, but the Bank of the South has "pledges" of $20b total and also has numerous disagreements about levels of funding for each country, and some countries arguing that the funding should be "donations." Guess what those "pledges" are going to be worth if that entire region gets hit? Squat.

    Is it a step in the right direction? Yes. Would it be of any significant help at all if Brazil were to have a major crisis, or if even multiple smaller member countries were in serious trouble? Not a chance. Those same countries would be knocking on the door of the IMF just the same.

    In this scenario, how do you feel about taking out a lung, "even when not necessary or required"?

    There's no reason to take a lung when the same punitive retribution for risky behavior can be accomplished with increasing costs and/or premiums. I'm all for tiered costs in collective benefit scenarios like health being associated with clearly identifiable and easily tested behaviors which incur additional costs for the entire system.

    Higher premiums and much higher % out-of-pocket costs for heavy smokers, drinkers, drug users, overweight citizens, etc is completely reasonable in my opinion.

    Of course you're entering some gray areas when it comes to certain behaviors and the cause/effect with diseases and health problems, so constructing the tiers and identifying the behavior threshholds is challenging (and of course there are some risky behaviors that cannot be easily tested for), but in the end absolutely worth the deterrent and also in establishing financial penalties for those that knowingly engage in risks and drive costs up for everyone.

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  17. Would it be of any significant help at all if Brazil were to have a major crisis, or if even multiple smaller member countries were in serious trouble? Not a chance.

    What does size have anything to do with this? Your initial claim was that no country was willing to form a collective body that would serve as a lender of last resort unless the price for resorting to that lender as "high and painful" -- at least as high and painful as IMF imposed on Korea in 1997.

    Bank of the South (and ASEAN+ countries' entry into currency swap agreements, which you ignore,) formed a consortium whereby the cost of lending was not as high and painful. How can this be the case, under your position?

    There's no reason to take a lung when the same punitive retribution for risky behavior can be accomplished with increasing costs and/or premiums.

    I thought you wanted the punitive retribution to be unreasonable? Now reason comes into play here?

    If all you want is to punish risky behavior, "even when not necessary or required[,]" why is taking out a lung different from having a higher insurance premium?

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  18. What does size have anything to do with this?

    Size has everything to do with this. The entire rationale for the harsh terms and austerity that the IMF imposes is based on the size of the bailouts (generally far larger in comparison to what is available from private lenders) and the fact that they are the last resort after countries have been turned down by every other available funding avenue. Those factors, in addition to the poor credit-worthiness (and thus high risk) of the countries being bailed out, combine to require strict terms.

    Your initial claim was that no country was willing to form a collective body that would serve as a lender of last resort unless the price for resorting to that lender as "high and painful" -- at least as high and painful as IMF imposed on Korea in 1997. Bank of the South (and ASEAN+ countries' entry into currency swap agreements, which you ignore,) formed a consortium whereby the cost of lending was not as high and painful. How can this be the case, under your position?

    Very simple: Because neither of those examples qualifies as a lender of last resort, nor do either meet the conditions of being similar in size, scope or mission to the IMF.

    I specifically laid out my challenge:

    If Korea (or other countries high on charity) believe otherwise, perhaps they can start their own version of the IMF and hand out hundreds of billions with low interest and no conditions attached to their economic competitors.

    The parts in bold require the challenge of finding something similar to the IMF in both size and scope, but without the harsh conditions. Your examples do not meet that standard.

    Of course smaller-scale and far less ambitious projects like the Bank of the South and the ASEAN+ swaps can offer better terms precisely because they are not lenders of last resort, because they are not tasked with giving massive loans to countries who are on the edge of a cliff, and finally because they are not required to deal with global stability ambitions and higher risks.

    Their purpose is regional, and it is to provide funding to countries who are still viable and possibly on their way to the cliff (not teetering on the edge), and in that scenario the lenders' risks are lower and draconian measures aren't yet necessary.

    The very nature and size of the bailouts required of the IMF, and the poor conditions of the receiver countries they deal with determine their strict terms. Your examples have neither the enormous responsibilities nor the
    large risk that the IMF does, and so are not comparable.

    I thought you wanted the punitive retribution to be unreasonable? Now reason comes into play here?

    Requiring significantly higher premiums and large additional % of out-of-pocket costs for smokers/drinkers/etc IS unreasonable and harsh when compared to the current reality, which imposes no such additional burden as far as I know in Britain or any other socialized medicine system.

    Just because you used a drastic example of organ removal, does not mean that I have to accept that as the standard of unreasonable or endorse it. Likewise, the terms imposed on Korea by the IMF were not comparable to a lung removal if you want to make comparisons.

    If all you want is to punish risky behavior, "even when not necessary or required[,]" why is taking out a lung different from having a higher insurance premium?

    Because I personally believe in economic punishment and not in extracting body parts. The fact that I endorse harshness and unreasonableness in both scenarios does not mean that I must accept every extreme example of it.

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  19. @dbagoo and Edward

    Maybe so. Maybe one could not expect Korea to continue with the same rate of growth. Nevertheless, I am very dubious about the IMF. When has it ever helped any country anywhere? Generally, it helps foreign investors at the expense of the local population, and that is what it is designed to do.

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  20. Because I personally believe in economic punishment and not in extracting body parts. The fact that I endorse harshness and unreasonableness in both scenarios does not mean that I must accept every extreme example of it.

    Because equating economic punishment and removing body parts would be... unreasonable? But I thought you wanted unreasonable? Now you have some type of "reasonable unreasonable" and "unreasonable unreasonable".

    The example of lung removal was not chosen lightly. The next part of the series will cover this, but the austerity demanded by IMF was unbelievably harsh. The biggest companies disappeared overnight. People lost jobs instantly. The number of homeless people increased astronomically. Suicide rates soared. Polarization of wealth accelerated. And Korea is still dealing with these trends.

    But one can grudgingly accept those consequences, if the austerity measures were necessary. But turns out, there were not necessary. Even IMF itself conceded that they were not necessary, as noted in the post. Not only was it unnecessary, but also it was suboptimal. It was more pain than necessary to resuscitate Korean economy. It was not like punitive insurance premium; it was like lung removal. And, like any person with a functional moral compass, you seem to admit that such action is unfair.

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  21. @Matt
    Yes I agree. IMF's demand for changes were ultimately beneficial to foreign investors.

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