Does Europe Have a Korean Option?

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.