The Hopeful Science
Does Europe Have a Korean Option?
Simon Johnson
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WASHINGTON, DC – On the surface, at least, the situation in the eurozone today and South Korea in the fall of 1997 look very different. Both are cases of severe economic crisis, to be sure. But the eurozone’s problems stem from high levels of government debt, while South Korea faced massive capital flight and a collapsing currency – and almost all of the debt was in the corporate sector.
Nevertheless, the eurozone could learn from the experience of South Korea, which came through its crisis more quickly than anyone expected, combining sensible reforms with a rapid recovery. The key to the South Korean turnaround was a large depreciation of the currency, the won. A depreciation of the euro seems to be one likely way that the eurozone will turn the corner.
Every crisis is different, but South Korea shared many features with other troubled emerging markets in the 1990’s. Large, politically well-connected groups of companies – known as chaebol – expanded rapidly by taking on large amounts of cheap debt. Outside shareholders had little influence over the powerful individuals who ran the chaebol, and creditors lent money freely, assuming that the leading chaebol were too important for the government to allow them to go bankrupt.
Meanwhile, political factors played an important role in allowing debt to build up – creating vulnerabilities that could quickly become an economic crisis once investors became nervous. Even though South Korean state-owned banks nominally controlled the flow of capital, tight relationships between the private sector and the government meant that the chaebol felt they had little to fear.
In the fall of 1997, after crises battered Thailand and Indonesia, full-scale panic erupted in South Korea. As the currency depreciated, the corporate sector’s foreign loans became more onerous – further exacerbating the panic. Early support offered by the International Monetary Fund did not stabilize the situation.
The eurozone today does not have a foreign-debt problem – all of the debt in question is in euros, and most of it is owed by European governments to their own countries’ banks. But this is a toxic combination, as Greece and Italy have discovered. European debt dynamics are quite distinct from those in South Korea, but the problem in both instances could be considered insurmountable.
The obvious escape route leads through economic growth, which would reduce the debt-to-GDP ratio and make interest payments look reasonable. But the standard ways to stimulate the European economy are not available: fiscal policy is constrained by already-high debt levels; and the European Central Bank, fearing inflation, has kept a tight rein on monetary policy.
None of the other ideas on the European table, including various kinds of “structural reform,” will provide fast growth in the short term. In September, Portugal planned to pursue a form of “internal devaluation,” by cutting payroll taxes and increasing the VAT; this has now been shelved, presumably because it is politically unworkable.
A genuine devaluation, on the other hand, would work wonders for the real economy. The moribund Italian economy would spring to life if the euro fell by 30%, adjusted for inflation. In 1997, South Korea’s economy took a nosedive, and 1998 was still difficult, but GDP soared by 11.1% in 1999.
How the euro would be able to depreciate, given that it is a floating currency with very little intervention – that is, the exchange rate is largely market determined – depends on monetary policy. If the ECB agreed to loosen monetary policy or provide enough “liquidity” to support various bailouts, investors would fear inflation, weakening the euro. On the other hand, if the ECB preferred to let major countries, such as Italy, default on their debts, this would likely weaken the euro even further, as investors feared a contagion of defaults.
While depreciation would never be eurozone officials’ stated policy, it currently looks like all roads lead in that direction.
Of course, currency depreciation is not a panacea. The South Korean situation also involved difficult steps, including a confrontation between the government and the largest chaebol, some of which had quite blatantly violated the law. After a series of showdowns, in which one company, Daewoo, threatened to default, and political forces rallied to its assistance, the government won; the hugely powerful Daewoo group underwent bankruptcy and restructuring. Overall, South Korea managed to curb its corporate sector’s excessive power (which holds lessons for dealing with today’s mega-banks).
Similarly, Europe needs to fix its deeper structural problems. It needs a fiscal center – much as the United States needed a federal authority to tax in 1787. Indeed, the Europeans need the equivalent of the US Constitutional Convention – and the difficult ratification debate that followed.
But some depreciation of the euro would provide a bridge to reach internal governance reform. And, like it or not, rising pressure on the euro is likely to force European officials to cross it.
Simon Johnson, a former chief economist of the IMF, is co-founder of a leading economics blog, http://BaselineScenario.com, a professor at MIT Sloan, a senior fellow at the Peterson Institute for International Economics, and co-author, with James Kwak, of 13 Bankers.
Copyright: Project Syndicate, 2011.
www.project-syndicate.org
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christnr 09:43 23 Nov 11
Unfortunately I don't see how devaluation can work for Euro-Europe as a whole in the way it helped Korea. The Korean economy is export-led, with exports now over 50% of GDP. The devaluation boosted the strength of this model, which works becuse the rest of the world can absorb the trade imbalance. But the Euro-Europe is too large for the rest of the world to aborb a run up in it's net exports, espacially with the US already near it's limit on negative balance of trade. Increased global trade may be part of the solution to improving global growth rates, but it will increasingly have to be toward a more balanced exchange.
Zsolt 10:05 23 Nov 11
I am sorry I am not an economist, but I cannot see any parallels to what happened in South Korea in 1997 to what is happening in Europe today.
First of all the Korean situation concerns a single country while in Europe we are dealing with multiple, fragmented, very different countries and economies which were brought together on a false, selfish idea in the first place.
But even if we ignore this very obvious difference there is a bigger problem.
Today we cannot view any problem, any economy, any country in isolation. The whole world, - not only the economy, but it is most obvious in economy and finances - has become global. This means that we exist in a closed, totally interdependent system.
Thus even if suddenly Europe would fix all the internal problems, the most perfect way (which nobody has any dea about) they still would rely on what happens to the global economy in general. And contrary to some opinion the world economy is not suffering because of the Eurozone problems, that is simply a sign of the much bigger problem, that the present economical model cannot function any more it is unsustainable.
In Europe, in the US, in China, India or anywhere else everybody repeats the same mantra: we adjust this, we fix that and when the growth starts again, and we turn around, we climb out of the recession everything will be good, like in a Hollywood movie.
But there will be no more growth or upturn as there nowhere to grow, and there is no cunsumer base that can initiate growth, on top of that most of our production creates totally unneccessary things which we do not need for a normal human life, they are actually harming us and the environment.
So instead of religiously waiting for a non-existent recovery, we need to understand this global, intermingled system we evolved into and start adapting to it.
There is no other viable option but mutual cooperation for all of us together.
21tiger 01:02 24 Nov 11
The Asian Economic Crisis of the late 90s happened because the Asian banks were too soft, and too favorable to companies that were just plain weak. It was a kind of corruption/nepotism that is fitting of an economy where the best companies in the country are rigged to support each other, and sponsored by the Government (Japan Keiretsu, Korea Chaebol). It was time for Asia to put on their big boy pants, and start seriously qualifying who they gave all this money to. I mean, are there parallels here to Euro which is basically an amalgamation of 'Good Enough' European nations (they were vetted before they got into the Eurozone of course), and now one of the countries (Greece) has fallen out of favor?
BillRylance 02:22 25 Nov 11
There is one significant difference between Europe 2011 and Korea 1997: Koreans are “One People” and were united in their response to the crisis, even to the point where housewives donated their gold jewelry (including wedding rings) to the government for meltdown. Also, the President of Korea at the time (Kim Dae Jung) did not blame "outside forces" for their plight and instead acknowledged that Korea's problems were of its own making. He then took tough decisive action and the majority of the population rallied in support. It was an extraordinary response driven by national pride and shared responsibility. I cannot see the glamorous ladies of Greece and Italy donating their gold and I doubt Europe’s politicians can drive a common and decisive agenda. Sure, Europe can learn from Korea, but does it have the collective and cohesive moral courage to respond like the Koreans? I think not.
lukehlee 10:07 25 Nov 11
The economic environment has been significantly changed in the Modern Information Age. I believe a serious mistake has been made in the market over the last 20 to 30 years, and it created an economic death spiral in the economy. Strangely, our economic experts have not considered this at all in their ruminations about the economy.
Even if the degrees are different, Korea currently also has a similar economic death spiral to that in euro zone countries and the United States.
Hope you will have a moment to see this: “The Real Cause of the Current Economic Crisis and a Suggested Solution” http://goo.gl/9y8Uf
Kiers 06:41 28 Nov 11
How come, the Euro is not at PARITY with the Dollar 1 = 1.? Surely this is uncomprehensible given all the other amounts of ink and fear the media throws on the topic of the Euro? The Euro would give the $ a run for the money!
rebentisch 07:21 23 Nov 11
If I am not mistaken there is no problem of the Euro but of single nations which introduced the Euro and their debt.
Similarly, Europe needs to fix its deeper structural problems. It needs a fiscal center – much as the United States needed a federal authority to tax in 1787.
It has a central bank in Frankfurt and sovereign nation states.