Silviase/jgov_v1.4_full_ann huggingface dataset:
existing agencies that supervised banks, securities houses, and insurance firms. The new agency was to be under the control of the Prime Minister's Office rather than the Minister of Finance and Economy (MOFE) in order to avoid undue concentration of power in the MOFE.

One of the government’s next steps was to initiate negotiations with the business and labor communities in order to build a consensus regarding solutions to problems based on the traditional approach of sharing the nation’s pains. On January 13, 1998 an agreement on five key principles of corporate reform was made between President-elect Kim Dae-Jung and the leaders of the top four chaebols. The agreement called for: (1) enhanced corporate transparency; (2) elimination of debt cross-guarantees; (3) capital structure improvement; (4) business concentration on core competencies and strengthened cooperation with small-and-medium-sized enterprises; and (5) improvements in corporate governance including toughened management accountability.

Negotiations with the labor unions were also undertaken but were very contentious. Korea's labor unions maintained a strong position against the introduction of layoffs, in keeping with business practice throughout the decades of rapid development and accepted social norms. However, one of the key conditions attached to the IMF bailout programs was increased flexibility in labor markets, including layoffs. A compromise seemed very difficult to reach in a short span of time. The Tripartite Commission, a labor-management-government consultative body, was inaugurated on January 15 to facilitate labor-management reconciliation. On February 6, after 20 days of painstaking negotiations, a pact among labor, management, and government was finally reached that was intended to make the labor markets more flexible and included provisions for layoffs – a first for Korea and a sharp break with previous practice.

The government rapidly established legal frameworks to implement reform programs based on the agreements. On February 14, ten economics bills, mostly revisions to laws related to labor and corporate restructuring, were passed during an extraordinary Assembly session. Under the new layoff law, companies were able to dismiss workers
without consent from their unions when the firm faced “emergency situations” such as mergers and acquisitions. Other legislation covered bankruptcy, corporate liquidation and employment insurance, all aimed at speeding up the reform of industry structure and financial markets. Hostile mergers and acquisitions of domestic firms by foreigners were allowed as the Assembly approved a bill on the introduction of foreign capital.

Following the introduction of the revised legal framework, the institutions to take charge of financial reform and restructuring were quickly launched. The KAMCO and its affiliated Non-Performing Loan Management Fund had been established on November 24 to address some of the problems in the banking sector. KAMCO, modeled after the U.S. Resolution Trust Corporation, was charged with resolving the non-performing loans from ailing financial institutions. A revamped Korea Deposit Insurance Corporation (KDIC), modeled after the U.S.'s FDIC, and the Financial Supervisory Commission (FSC), an integrated financial supervisor, were newly created on April 1, 1998. The KDIC took charge of maintaining the stability of the financial system by protecting depositors, supporting the resolution of insolvent financial institutions, and providing capital to banks, while the Financial Supervisory Service (FSS) monitored and inspected the financial industry more closely.

Table 3 Chronology of Korea’s Financial Crisis (1997 – 1998)

1997

Nov. 21 Request for IMF bailout loans announced

Nov. 24 KAMCO and NPL Management Fund Set Up

Dec. 3 Agreement with the IMF on bailout programs

Dec. 18 Presidential election. Kim Dae-Jung elected

Dec. 22 Emergency Economic Committee Launched

Dec. 29 Package of 13 financial reform bills passed

Jan. 13 Agreement on five key principles of corporate reform between President-

Jan. 15 Inauguration of Tripartite Commission to discuss labor issues
Feb. 14 Ten economics bills on corporate and labor reforms passed

Feb. 18 Kim Dae-Jung Inaugurated as 15^{th} President

March 11 Opening of first meeting of the Economic Policy Coordinating Council

April 1 Financial Supervisory Commission Established

April 1 Consolidated KDIC Launched
### I II. The Causes of the Crisis

A number of analyses of the Korean financial crisis have been conducted and a variety of causes have been proposed. $ ^{7} $ Economic and institutional factors provide a picture of an economy ripe for a sharp downturn. A more complete understanding of the causes of Korea’s crisis and its failure to anticipate the crisis, though, requires consideration of a number of cultural factors as well as standard economic analysis.

## Economic Analysis of the Causes of the Crisis

The Korean crisis reflected the combination of a number of vulnerabilities. Most immediately, the sudden outflow of foreign currency led to depletion of foreign currency reserves and skyrocketing won/dollar exchange rates. Deteriorating balance sheets of financial institutions, high levels of short-term debt in the private sector, and a string of bankruptcies among chaebols shook investor confidence, along with the epidemic of crises in neighboring countries. Many of the economy’s fundamental problems can be traced to the structure of its corporate sector and difficulties in its immature labor and financial markets.

Figure 6 Causes of Korea’s Financial Crisis
Economic and institutional causes of the crisis can be classified into three general categories: liquidity problems, structural problems, and external shocks. First, it is widely acknowledged that insufficient foreign currency reserves triggered the crisis. Korea's high level of short-term external debt and heavy debt ratios in the corporate sector hurt investors' confidence. At the end of 1996 the ratio of short-term debt to reserves was 2.0 and the debt/equity ratio reached nearly 400 percent, both high by international standards. Foreign investors worried about the rapid increase of nonperforming loans in the financial sector due to the many bankruptcies. The ratio of NPLs to total credit increased from 5.2 percent at the end of 1 $ ^{st} $ quarter to 6.0 percent at the end of 4 $ ^{th} $ quarter of 1997 due to corporate bankruptcies. Additionally, the Korean won was overvalued against the dollar. Although Korea did not have a fixed exchange rate system like Thailand and Malaysia, the won seemingly was overvalued due to the relatively small adjustment band.
Table 4 Ratio of Short-term Debt to Reserves (1996)

South Africa	Pakistan	Russia	Singapore	Bulgaria	Korea
11.6	5.1	2.3	2.3	2.1	2.0
Indonesia	Argentina	Mexico	Zimbabwe	Thailand
1.9	1.4	1.4	1.3	1.2

Source: Bank for International Settlements, International Financial Statistics (1997)

Table 5 Comparison of Corporate Debt by Country (%)

Korea	Malaysia	Thailand	Taiwan	Japan	U.S.	Germany	Sweden
Corporate Debt/GDP	167	200	86	170	130	60	53	91
Debt/Equity	395	160	450	90	194	106	144	154

Source: IMF (1998), Republic of Korea—Staff Report for 1998 Article IV Consultation

Table 6. Trend of Non-Performing Loans (billion won)

1997 Q1	1997 Q2	1997 Q3	1997 Q4	1978 Q
Total Credit (A)	326,094.5	331,572.3	343,363.3	375,831.7	354,602.4
NPLs (B) $ ^{*} $	16,864.9	17,287.1	22,438.4	22,652.1	25,998.2
B/A (%)	5.2	5.2	6.5	6.0	7.3

Source: MOFE (1998)

$ ^{*} $ Includes credit classified as substandard, doubtful and estimated loss.

Second, a variety of fundamental weaknesses in Korea’s economic structure have been identified, particularly in the financial, corporate, government, and labor sectors. In the financial sector, institutions overextended credit and tended to concentrate lending in a few industries. In funding that lending, banks mismatched maturities and currencies, leading to magnification of the credit quality problems. In the corporate sector, the chaebols pursued excessive expansion with borrowed money, and a lack of transparency in corporate governance undermined investors’ confidence. In the labor market there was
a lack of flexibility, including especially the inability to implement layoffs. The government failed to manage the foreign exchange reserves appropriately and neglected exchange rates difficulties. It ignored the high level of short-term debt in the private sector and failed to provide adequate supervision of the financial sector.

Third, external shocks -- especially the contagion effect of the Asian financial crises -- contributed substantially to Korea’s difficulties. Difficulties in the region led to a closer examination of Korea’s fundamentals by foreign investors and intense competition hastened the deterioration of exports. The contagion effects of the foreign exchange crises were evident even at the time. In considering how the difficulties in the small economy of Thailand spread to much larger economies, including Korea, Goldstein (2001) explained the channel of contagion. Thailand’s difficulties provided a “wake-up call” for investors to reassess their investments in Asia, and one country’s currency devaluation could lead to competitive devaluations of neighboring countries’ currencies.

These economic factors indicate several profound underlying weaknesses in Korea’s economy, despite its apparent strength in the months immediately before the crisis. Once conditions began to deteriorate, Korea’s economy fell into a crisis rapidly.

## Failure of Korean Style Cooperative Measures

Why did a healthy-looking Korean economy collapse so suddenly? Although some corporations had financial problems, the overall macro-economy of the country looked healthy until about a month before the crisis. The rapid transfer of firm-level problems to the national level is closely related to the flaws in a corporate structure, chaebols, that stressed burden-sharing among affiliates. Similarly, the microeconomic difficulties within Korea’s chaebols were made worse by the country’s overall macroeconomic condition. The domestic origin of Korea’s crisis can be traced to structural weaknesses in the financial and corporate sectors. A series of chaebol bankruptcies began with Hanbo in January 1997 and peaked when Kia Group revealed its financial difficulties in July 1997.
Because of the relationships among firms within a chaebol, one company’s problems could quickly extend to all companies in its group. The Kia Group provides a prime example. Kia was the eighth largest chaebol with a total of 28 affiliates. In the summer of 1997, the Kia Group began to experience financial difficulties because of its heavy debt burden and reduced cash flow during the business slump. At the end of May 1997, Kia had 9.5 trillion won in debts to the financial sector. The large debts and losses were attributed primarily to three affiliated companies -- Kia Steel (producing special steel products), Asia Motors (buses and trucks), and Kisan (construction). The problems at these three eventually led to cash flow problems for the group as a whole. $ ^{8} $ While western business practice would suggest that Kia Group quickly close or sell off its ailing subsidiaries, the chaebol structure and culture did not permit this. Because of protests by managers and workers, Kia Motors could not be sold and would likely have failed with the rest of the group.

Korean chaebols operated somewhat like a family. Parent companies looked after their affiliate companies and sibling companies provided mutual aid. Chaebol culture dictated that it was keenly necessary for affiliates to help each other in adversity, even when a more practical (western) business strategy would be to let an ailing affiliated company fail so that the other companies can survive. Cross debt guarantees by the parent company and cross shareholding among affiliates helped provide easy access to credit and financial supports. $ ^{9} $ Intra-group transactions among affiliates served as a key strategy for the conglomerates to expand business, but these practices can also lead to collective insolvency of the conglomerate as a whole if business turns bad. Additionally, relationships between chaebols and the banking sector can lead to non-optimal credit risk management. In the case of the potential bankruptcy of the Kia Group, the massive
increase in non-performing loans would have threatened the viability of the chaebol’s creditor banks.

The structure and culture of Korea’s banking sector also contributed to the rapid collapse in 1997. The Corporate Bankruptcy Postponement Accord is one example of the linkages among banks and the barriers to prompt resolution of problems. In April 1997, the nation’s 35 state-run and commercial banks signed the Corporate Bankruptcy Postponement Accord. Under the Accord, creditor banks agreed to provide rescue loans for a group’s key affiliates under a cooperative agreement to prevent a chaebol that is temporarily suffering cash-flow problems from being forced into bankruptcy. Under the Accord, lenders would be financially penalized if, without consent from their colleagues, they prematurely collected loans from companies where the primary creditor bank had requested assistance. Western bankers doubted that the Accord would be able to achieve its goals and were opposed to its cooperative framework. Rather than require each lender to evaluate each credit decision, the Accord undermined the lenders’ responsibility and forced them to maintain troubled credits. While propping up the struggling chaebols may have been socially desirable in the short run, the Accord only strengthened linkages among the already weakened lenders.

Between April and November 1997 the Jinro, Daenong, and Kia Groups benefited from the Corporate Bankruptcy Postponement Accord and were able to shift their corporate financial troubles to the financial sector. Because of the Accord, all financial institutions were affected, without distinction between originally healthy or unhealthy institutions. Because of the cooperative action, banks could not reduce loans to troubled borrowers and lost the opportunity to resolve non-performing loans promptly. The Accord allowed weaknesses in several creditors to spread to the entire banking sector.

These problems at the chaebol-level and within the banking sector quickly extended to the national level. From July on, Korea’s primary economic problem was the fallout from Kia’s financial crisis. Under the Corporate Bankruptcy Postponement Accord, creditors were considering selling the profitable Kia Motor. However, Kia
managers wanted to survive by implementing a self-rescue plan, and its labor union protested fiercely against selling Kia Motor. In addition, civic groups launched a campaign to save Kia under the slogan, "Let's save Kia, a company of people." $ ^{10} $ The resolution of Kia continued to be delayed, and the government eventually intervened. It placed the group's two auto-manufacturing units -- Kia Motor and its subsidiary Asia Motor -- under court receivership. Kia Motor was to be recapitalized with state funds and operated as a public company until its management was normalized. $ ^{11} $ The Korea Development Bank, a state-run bank, converted Kia's debt into investment capital. Domestic business welcomed the government decision to intervene, and stock prices rebounded.

Foreign investors’ reaction to Korea’s difficulties was completely different from the domestic reaction. On October 24, two days after the government announced a rescue plan for Kia, Standard and Poor’s, a U.S. credit rating firm lowered its rating on Korea’s long-term foreign-currency sovereign debt to single A-plus from double A-minus. This was the first time the nation’s credit rating had been cut, although some of Korea’s corporations and banks had been downgraded. S&P explained its action citing “the escalating cost to the government of supporting the country’s ailing corporate and financial sectors.” The government rescue of Korea First Bank (KFB) in September made the government’s official backing of the banking system’s obligations increasingly explicit. On November 28, three days after the KFB rescue, another U.S. credit rating agency, Moody’s also cut Korea’s sovereign debt rating from A1 to A3. The credit-rating downgrades dealt a severe blow to Korean corporations and financial institutions that were already struggling to secure foreign-currency funds. The credit-rating downgrade initiated an abrupt outflow of foreign capital and fall in the currency. The events of these weeks were only exacerbated by the Hong Kong stock market shock that had occurred on October 23, and the worldwide reaction to that stumble in a neighboring Asian economy.
To a large extent, then, the chaebols' cooperative corporate structure and approach to "live and die together" by sharing burdens and risks among affiliates brought about Korea's crisis. Firm-level difficulties that would have been recoverable, small troubles if they had been addressed and resolved quickly, developed into a national disaster as they spread from a company to a group, from a group to the financial sector, and finally to the national macro-economy. The Korean business approach based on cooperation had been effective during the period of rapid growth of the 1970-80s. However, as Korea entered the global economy and its business sector was forced to coexist with western-style individualistic capitalism, its cooperative corporate structure and culture based on familism proved to be a profound weakness.

## Earlier Failure to Gain Sufficient Support for Reform

Why could Korea introduce and implement reform packages so quickly? How had Korea reached consensus on labor and corporate reform, revised its legal framework, and established institutions for financial restructuring within six months of the crisis? The answer is simple: Korea had been preparing for reform well before the crisis.

At the end of 1996 and into the beginning of 1997 Korea had experienced a shock in response to a slump in exports. Concerns about the country’s macroeconomic condition were reflected in the dramatic drop of the KOSPI in January 1997. At that time, the Korean government had already recognized that structural problems in two areas in particular impeded sustainable growth: labor markets and financial markets. It prepared two reform plans -- a financial market reform package and a labor reform package to increase market flexibility. Although the government worked to build support for the reform packages and have them passed by the National Assembly, the reform plans did not win widespread support until the economic crisis occurred in November 1997.

In 1996 the government proposed labor law reforms to permit lay-offs and introduce some labor market flexibility measures. Labor unions and the opposition parties protested fiercely, however. The National Assembly passed the laws in December 1996.
in a predawn parliamentary session with only lawmakers from the ruling party attending. The highly unusual passage of the reform measures touched off nationwide labor protests, and President Kim Young-Sam promised to rewrite the laws in January 1997 and then postponed their implementation for two years. In the end, necessary reforms, including lay-offs, were not implemented until a full-blown financial crisis occurred.

In 1997 the MOFE proposed a package of 13 financial reform bills to initiate the Korean version of the "Big Bang." The bills called for the central bank, the BOK, to act as an independent authority over monetary policy with the head of the BOK replacing the Minister of Finance and Economy as the head of the policy-setting Monetary Board. To enforce supervision in the financial sector, a consolidated Financial Supervisory Commission (FSC) was proposed through the merger of the three independent regulatory bodies for banking, securities, and insurance. The Office of Bank Supervision within the BOK was to relinquish its inspection rights over banks to the soon-to-be-established FSC. Under the proposals, all financial companies would be supervised under the new FSC. Deposit insurance funds were to be merged as well. Korean business groups, chaebols, would be required to prepare and publish consolidated financial statements linking the performances of all of their subsidiaries by fiscal year 2000.

The majority ruling party promised to support passage of the reform package at the general assembly session in September, but passage of the reform package was delayed while the government worked to achieve political consensus between majority and minority parties. As the session’s close drew near, passage seemed assured as the government secured a favorable response from opposition party leaders. Newspapers incorrectly reported that the political parties had reached an agreement and the reform package would be passed on November 14. By November, though, Korean financial markets already showed signs of instability, and there were rumors that Korea would need help from the IMF in the near future. Experts urged passage of the reform package, praising it for its contribution to restructuring Korea’s inefficient financial sector and stabilizing its financial markets. Political consensus, though, remained elusive. The opposition party did not formally oppose the reforms, but it did not support them actively.
and its members did not attend the session when the vote was to be taken. Although it held a majority, the ruling party hesitated to enact the reforms without participation by the opposition party for fear of losing votes in the upcoming Presidential election.

On November 14, the BOK and the three financial supervisory bodies held a joint rally in front of the National Assembly to protest possible passage of the financial reform bills. They complained that the BOK would be stripped of supervisory authority over banks, suggested that the merger of the regulators would provoke instability, and criticized the fact that the new FSC would be under the control of the MOFE. Trade unions at financial institutions nationwide threatened to launch a general strike to support the central bank employees' protest. Lawmakers from both the ruling and opposition parties suddenly became reluctant to pass the reforms, each party fearing the loss of popularity ahead of the presidential election to be held on December 18. On November 17, the Korean won broke the psychological barrier of 1,000 per U.S. dollar for the first time on, closing at 1,008.60 on the back of foreign currency shortages and uncertainty over financial reform bills. Eventually the financial reform package was not passed until after the crisis occurred.

It is generally said that the failure to pass reform measures that might have averted Korea’s financial crisis can mainly be attributed to a lack of leadership $ ^{12} $ and to politicians’ irresolute search for popularity. However, it is difficult for even a strong political leader to push reform measures that are not supported by the majority of citizens. This is the nature of democracy. Public attitudes needed to change before reforms could be introduced and implemented. $ ^{13} $ A pertinent issue is the basis of the public attitudes that led the initial failure of the reform efforts. In many ways, Korea’s culture based on cooperativism/collectivism and humanism kept it from introducing reforms that, in the long run, would allow it to better compete in international markets.