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Financial Crisis and Prospects for the Future

Financial Crisis and Prospects for the Future. Chapter 14. Stages of Development. World Bank classification Low income economy (per capita GNI < $745 in 2001 prices) Middle income economy High income economy (per capita GNI > $9205 in 2001 prices) Michael Porter ’ s development stages

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Financial Crisis and Prospects for the Future

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  1. Financial Crisis and Prospects for the Future Chapter 14

  2. Stages of Development • World Bank classification • Low income economy (per capita GNI < $745 in 2001 prices) • Middle income economy • High income economy (per capita GNI > $9205 in 2001 prices) • Michael Porter’s development stages • Factor-driven stage • Investment-driven stage • Innovation-driven stage

  3. Korea’s Visions by Decade • 1960s: Growth at any cost to catch up with and surpass North Korea • 1970s: HCI (heavy and chemical industry) drive in pursuit of self-defense and self-reliance • 1980s: Democratization • 1990s: Globalization • 2000s: High income economy/innovation-driven economy (a core economy)

  4. Factors Behind the 1997 Financial Crisis • Change of economic policies’ general direction • Supply factors • Demand factors • Management • Firms and industries • Government • Internationalization • Chance variables

  5. Foundations Weakened • President Kim Young-Sam: pro-(labor)union, anti-chaebol, anti-capitalist • Thirty decades of opposition (to Park Chung Hee, Chun Doo Hwan and Roh Tae Woo) • Trying to reverse the policies of his predecessors • Specific policies included: • Encouraging high wages • Maintaining high interest rates • Overvalued currency • Discouraging borrowing by big firms from the government-controlled banks • Hyundai group could not get loans from the banks due to which it avoided the dire effects of the 1997 crisis • These policies have greatly weakened Korea’s global competitiveness

  6. Supply Factors • Four Highs • Wages (increased production costs reducing competitiveness of exports) • Interest rates (borrowing for investment into capital more expensive) • Land prices (land is part of the businesses’ fixed costs of production) • Consumer goods prices in general • Three Lows • Technology • Efficiency • Value added (difference between sales and costs)

  7. Demand Factors • Overvalued Korean won made it cheaper for Koreans to buy foreign goods thus hurting domestic industries, including the export-oriented ones • Deterioration of exports decreased Korean global competitiveness • Both domestic and foreign markets are hurt

  8. Management • Management has been historically growth-oriented, global competitiveness not an issue • Family-type system of management often resulted in cronyism • Hanbo Steel

  9. Firms and Industries • Excessive government regulation made it very difficult to start a new firm in Korea • Big firms being the backbone of the Korean economy made foreign borrowing excessive • Korean banks largely considered a policy instrument for the government rather than financial intermediaries channeling savings into productive investments • Financial sector underdeveloped, did not meet international banking standards • Banks’ capacity to evaluate risks and benefits of investment projects (crucial for making sound decisions on loans!) extremely low

  10. Government • High wages, high interest rates and overvalued currency • All three undermine Korean global competitiveness • Erosion of global competitiveness resulted in low stock prices so firms could not gain much from being traded on the stock exchange • Tight monetary policy led to scarcity of domestic loans making interest rates exceed the international ones which in turn made foreign borrowing more attractive

  11. Internatiolization • Kim Young Sam’s goal of joining OECD required liberalization (opening up) of domestic capital and financial markets to the rest of the world • Korean financial sector was highly underdeveloped at the time • Private sector used liberalization to borrow more, making Korea more vulnerable to fluctuations in the world economy, also more indebted

  12. Chance Variables • Chance variables are economic factors exerting substantial influence on the economy but also being out of control by the domestic government • Japan’s economic slowdown in 1990s (recession) • Economic crisis in Indonesia and Thailand • Worldwide decline in demand for computer chips, ships, automobiles and textiles

  13. Economic Effects of the World Cup • Increase in self-confidence and self-assurance • Improved image of the country • Increase in competitive spirit • Tourist spending

  14. 2010: Projection of Korea’s Standing

  15. Directions of Development at Innovation-Driven Stage • Expand government spending on R&D • Promote venture capitalism (simplify procedures of going public/getting listed on stock exchange thus allowing small and medium-size firms to borrow funds directly from the general public by issuing stocks) • Improve financial and legal arrangements for new startups • Improve legal procedures for intellectual property rights • Reduce government interference in the economy

  16. Advantages of Korean BGs (Chaebols) • Economies of scale and scope • Information collection and use, especially important in the global knowledge-based era • Use of management resources • Financial mobilization and allocation • Global marketing • Education and training of employees • Bargaining power

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