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Catch-up and Crisis in Korea

Wontack Hong

Whilst the process of catch-up in Korea – led by export-oriented growth – has been rapid and, in a sense, very successful, it has also been subject to turbulence, not least in a crisis of near bankruptcy that has dramatically revealed its Achilles heel. Informed by the 1997 crisis, Wontack Hong writes a new history of the Korean economy; one that seeks to understand export-oriented catch-up in newly industrialized countries (NICs) whilst offering a realistic appraisal and forewarning of the pitfalls which could signal self-destruction.
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Chapter 8: The Legacy of Korea’s Credit Rationing System

Wontack Hong


1. A REPRESSED FINANCIAL REGIME In Korea, commercial banks were the principal intermediary between savers and borrowers, and yet bank credits were provided at below market rates, which made credit rationing unavoidable. Indeed, credit rationing served as one of the most important policy tools to carrying out exportoriented growth strategy in Korea (see Hong 1986a, 1986b). According to the McKinnon-Shaw models, the growth-maximizing real deposit rate of interest is the competitive free-market equilibrium rate (see the summary by Fry, 1993: 8–11). The policy implications of these models for the financially repressed economy are that growth can be increased by abolishing interest rate ceilings, by reducing the rate of inflation, by abandoning credit rationing, by eliminating the reserve requirement tax (for example, by paying the competitive interest rate on required reserves), and by ensuring that the financial system operates competitively under conditions of free entry. Higher real deposit interest rates not only increase financial deepening but also raise national savings, increase the supply of available investment resources, accelerate the rate of physical capital accumulation, and hence raise the equilibrium rate of national investment. The financial liberalization undertaken in Korea in the 1980s was rather moderate. Interest rates as well as the asset management of financial institutions continued to be controlled, and the government still heavily intervened in money and capital markets. However, since it is a fact that Korea could achieve sustained high growth with ever-rising savings propensity under a repressed financial regime, and since Japan also to some...

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