Abstract

　Focusing on corporate governance and financial resource allocation mechanisms under various regimes, this paper uses the concept of path dependence and comparative institutional analysis to trace the evolution of Korea's development paradigm and to assess the extent of changes in the Korean economy since the 1997 economic crisis.

　In the early 1960's, Korea addressed the policy challenges of economic development by essentially combining a state-led allocation of financial resources and an export market orientation. The government nationalized banks and restricted inward foreign direct investment while providing repayment guarantees to foreign financial institutions on loans extended to Korean firms, most of which lacked the standing in the international financial markets to raise capital on their own. Scrapping the import-substitution bias of the 1950's, the government removed various market distortions that had made it difficult for firms to exploit profitable investment opportunities. Korea's development paradigm, which centered on the idea of government-business risk partnership, proved an effective choice given the country's resource endowment at the time.

　From the outset, the government sought to contain idiosyncratic moral hazard, but systemic risks began to build up as apparently successful firms kept borrowing to expand their business. When an economic slowdown threatened to topple heavily indebted firms in 1972, the government decided to bail out the debt-plagued corporate sector and imposed a debt moratorium on curb loans—without holding the incumbent managers and owners responsible for their previous business decisions. The ensuing heavy and chemical industry drive further weakened investment discipline as the government increasingly directed private firms to carry out targeted projects.

　Disturbed by the distortion of the government-business risk partnership, some technocrats began to advocate a transition to a more market-oriented paradigm as early as the end of the 1970's. Although domestic and foreign pressure for liberalization and democratization did lead to the weakening of government control, institutional reforms required to improve corporate governance and financial resource allocation were not implemented. In fact, what might be called "de-control without de-protection" proceeded as family-based business groups known as the chaebol took advantage of liberalization and the government's implicit guarantee against their bankruptcy. The 1997 crisis should be understood within this context.

　In the post-crisis era, changes in the risk profiles of economic activities, combined with the collapse of the authority hierarchy after the crisis, seem to be the primary drivers behind Korea's evolving development paradigm. The transition from the old government-business risk partnership to a more market-oriented paradigm, however, has been difficult. Although the government has swiftly dealt with the massive nonperforming loans problem, it has been far less willing to take substantive measures designed to put financial institutions in a position to lead corporate restructuring based on market principles. As long as Korea continues to harbor structural problems in the areas of corporate governance and the allocation of financial resources, however, the investment efficiency of the economy is likely to suffer, making it extremely vulnerable to macroeconomic shocks. The reform program should focus on improving the autonomy of the financial sector and introducing private remedies to address the problem of corporate governance.