The South Korean Crisis of 1997 and its Aftermath: The Legacy of the Developmental State and the Importance of State capacity in Post-Crisis Adjustment

The East Asian, particularly the South Korean, crisis has not been an anticipated one. The East Asian experience in the 1970s and 1980s consisted of high growth based on export competitiveness and large capital account surpluses. While performance was perhaps weakening in some of these economies following their exposure to financial globalization, returns on assets were generally high. Yet, the continuation of high levels of investment in the region was clearly facilitated by a heavy reliance on external financing. Towards the mid-1990s, these economies became increasingly dependent on shortterm foreign borrowing and portfolio flows, which, if suddenly withdrawn, as indeed it was subsequently the case, would cause very real effects on the macro-economy. The massive reversal of capital flows clearly did not fit the profile of the “traditional” balance of payments crisis in which monetary and particularly fiscal policy generated unsustainable current account deficits. What was quite paradoxical from a traditional IMF perspective is that in none of the most seriously affected East Asian countries had budget deficits in of a problematic nature. In fact, a number of the countries in the region even recorded budgetary surpluses. It was not surprising, therefore, that the East Asian crisis has sparked a large body of literature seeking to explain causes of this unusual crisis, re-igniting fundamental debates about the respective roles of governments and markets, at both the national and international level, in the process. Since the East Asian economies are generally characterized as blessed with an activist developmental state, the role of the developmental state has became one of the contentious issues emerging from the debates concerning the causes of the crisis. When the Korean crisis first broke out in November 1997, many commentators regarded this as the proof of its famous state-led economic system has reached its limit and what needed to cure the country’s economic ills was to ditch the inefficient and corrupt statedirected economic system and create in its place a “genuine” market economy. The aim of the paper is threefold. Firstly, it examines the extent to which the developmental state itself was the cause of the crisis. Secondly, it attempts to provide a critical perspective on the role of the IMF in the post-crisis period. Thirdly, attention is focused on the underlying dynamics of the strong recovery process in the post-crisis era in South Korea, a pattern that makes a strong contrast with other “emerging markets.” A central argument is that although the old-style of the developmental state in Korea has significantly declined, it still possesses a substantial amount of state capacity. Indeed, the legacy of the developmental state has been instrumental in South Korean comparatively successful adaptation to the environment of financial globalization in the post-crisis era.