I. The Arguments
The prominent characteristics of the political economy of finance in
developing countries are related to the state’s strong intervention in
the allocation of finance as a rent-seeker or an upholder for economic
development. The state has strong incentives to control the flows of
capital because it is an important political resource in structuring and
restructuring the economy by encouraging the capitalists to invest into
certain sectors the state prefers. As in many developing countries, the
financial system in both Korea and Indonesia has been tightly controlled
by the government in the 1960s and, especially, the 1970s. Their
financial system was what Zysman (1983) called a “credit-based system
with critical prices administered by government.” The central banks
(Bank Indonesia and The Bank of Korea) had little autonomous power in
making monetary policy. Major commercial banks were owned and operated
by the government and their larger parts of loan practices were made by
preferential credit allocations with privileged rates. The prices of
lending money were set by the government, not by commercial banks.
In the 1980s, however, both governments began to liberalize the
financial system as the response to economic crises during this period,
surrendering much of the state’s power over the flow of capital to the
market. Korea and Indonesia, however, showed us a different style of
financial liberalization in terms of its speed and scope. When the
financial liberalization of Korea in the 1980s and the early 1990s is
compared with the Indonesian’s, one contrasting feature is that Korea’s
progress has been very prolonged and gradual. Freeing interest rates,
eliminating preferential credit allocation, and liberalizing capital
movements were very slow or unsuccessful. The Indonesian financial
reform in the 1980s, by contrast, was implemented with the rapid and
sudden removal of regulations. In 1983, the government announced
removal of all bank credit ceilings and also of interest rate ceilings,
and, in 1988, opened up banking sector to new entrants both foreign and
domestic by allowing them to establish new banks and branches.
The main purpose of this paper is to find out what factors contributed
this difference in the processes of the financial liberalization of the
1980s in Korea and Indonesia. The main arguments are based on the idea
that the speed of financial liberalization is influenced by two things:
the degree of economic crises and the power relationships between the
government and business. Two arguments can be made.
Argument 1: The worse balance of payments crises are, the more likely is
that the
government liberalizes its financial
system rapidly.
The reason why the degree of balance of payments crises is important in
explaining the speed of financial liberalization is that economic crises
reduce the government’s ability to keep preferential credit policies by
decreasing the government’s availability of capital. The more serious
crises means the less capital availability so that the more possibility
for the government to liberalization the financial system. Decreased
access to foreign capital makes the government more difficult to expand
preferential credit schemes and pushes it toward liberalization
(Haggard & Maxfield 1993). In the absence of serious balance of
payments of crises, the Korean government was able to retain the ability
to respond to big business’ pressures to keep preferential credit
schemes. In addition, this lack of serious economic crises made
possible that the government was under little pressure to liberalize
capital movements controls (Haggard & Maxfield 1996). Indonesia,
however, experienced much more acute economic crises during the 1980s
due to the plummeting of oil prices. The financial reform package of
1988 was the result from the serious balance of payments crises during
the later part of the 1980s.
Argument 2: The process of financial liberalization once initiated by
economic crises is
influenced the power relationships
between the government and business.
When the government has less
autonomous power vis-a-vis segments of
business who have benefited from the
preferential credit regimen, financial
liberalization is more likely to be
made in a slow and gradual fashion, and
vice versa.
There are three main factors influencing the power relationships
between the government and business: the structure of the state and
business and the nature of networks between the state and business
(Fields 1997). First, when the state has internal coherence among
bureaucratic organizations, it will enjoy autonomy from business,
whereas the state lacks internal organizational coherence, it is like to
be a rent seeker. Second, the power relationships of business vis-a-vis
government varies according to its structure. Small numbers but
concentrated and conglomerated firms will increase the influential power
of business in the economic decision-making (Schneider & Maxfield 1997;
Shafer 1997). Finally, how the nature of networks between the
government and business influences government-business relations is
needs to be considered in the conjunction with economic crises. It is
reasonable to think that the effectiveness of business influence during
economic crises is less when the networks are based on personal and
informal connections than when they are based on formal and
institutionalized ones because personal connections are supposed to be
easily broken during economic crises. For example, influential business
people who have benefited from the preferential credit regime will lose
their political patronage as economic crises increase deregulators’
influence within the government. This might be the case for Indonesia
during the 1980s. When the patron loses his/her political power, the
business people will go down with him/her (Irwan 1989:407).
Institutionalized and group-based networks, however, serves as means
through which business groups can influence on the process of financial
liberalization even if there is the change of power relationships among
bureaucrats within the government because the networks do not change
easily during economic crises. Korea is close to this case.
II. The Korean Experience of the Financial
Liberalization in the 1980s
1. The Heavy and Chemical Industrialization(HCI) and Preferential Credit
The Korean financial system has been tightly controlled by the
government and shaped by the course of industrial policy during the
1960s and 1970s. During this period, the government’s financial policy
was basically to ensure that sufficient financial resources could be
provided to the industrial sectors and firms that were favored by the
government’s industrial policy (Choi 1993; Woo-Cumings 1991). The
organized financial sector was completely subject to industrial policy
priorities set by the government. This subordination of financial
sector to industrial policy was much more intensified with the beginning
of the Heavy and Chemical Industrialization (HCI) drive in the 1970s.
The HCI policy was possible because huge petrodollars “without political
strings attached” were poured into Korea during the 1970s and the early
1980s (Woo-Cumings 1991:150).
The sate-led heavy industrialization drive was not welcomed by even the
major big business groups, chaebol, because of the high market risks,
uncertainties, and long gestation periods involved in making huge
investments in the targeted industries. In order to induce the chaebol
to participate in the strategic sectors, the government poured as much
capital as possible into these sectors. To finance huge capital
investments, the government had to further tighten its control over the
allocation of capital. The easiest and surest way to channel funds to
the strategic sectors was to earmark a portion of all commercial bank
lending as “policy loans” through the National Invest Fund, established
in 1974 (Choi 1993; Koo & Kim1992). In the second half of the 1970s,
somewhere between 53 % and 63% of the total domestic loans were
distributed as policy loans at preferential rates. Loan rates were
always lower for export industries than industries producing domestic
consumption, for heavy industries than light ones, and for large
manufactures than small ones (Woo-Cumings 1991: 166). Approximately 70%
of the policy loans went to the heavy and chemical industry sector. The
majority of these loans were given to chaebols, since they were the ones
who were assigned these strategic projects (Koo & Kim 1992:136).
2. The Changing relationship Between the Government and Big Business
The heavy industrialization drive during the 1970s through preferential
credit schemes began to change the relationship between the government
and big business. While large conglomerates were formed and developed
by the state’s planned industrialization policies, they came to enjoy
high leverages in the government’s economic policymaking as their size
and economic weight grew dramatically during the heavy industrialization
period. Between 1972 and 1979, the average number of firms owned by top
10 chaebols grew from 7.5 per chaebol in 1972 to 25.2 in 1979. And the
number of different industries in which they operated increased from an
average of 7.7 industries (by two digit industrial classification) in
1972 to 17.6 in 1979. As a consequence, the share of top 10 chaebols’
sales in GNP increased from 15.1 % in 1974 to 48.1 % in 1980 (Koo & Kim
1992: 136-7). The large conglomerates learned that to ensure the
uninterrupted flow of credit, they needed to “become large enough that
the possibility of bankruptcy would pose a social threat” (Woo-Cunings
1991: 13). “The bigger, the better” was the chaebol’s basic growth
strategy during this period.
The organizational structure of business and institutionalized networks
between the government and big business enhanced the economic power of
big businesses vis-a-vis the government. Small numbers but multisetoral
diversification of the chaebol allowed them to protect their interests
in the process of the financial liberalization, overcoming the
collective action problems (Shafer 1997). More than two hundreds of
business associations, which previously functioned as effective conduits
for passing information from business to the government and for
transmitting order, regulations, and guidelines to specific sector and
firm, served as mechanisms through which the chaebol excise their
economic power to make favorable financial policies. The Federation of
Korean Industry (FKI), the most powerful business association for the
chaebol, has been effective lobbying group for chaebol interests (Fields
1997). For instance, according to Shafer (1994: 138), the government
now, in contrast to the 1960s and 1970s, accepts 90 percent of FKI’s
policy recommendations.
In contrast to Korea, Indonesia has experienced very different
government-business relations. By the early 1980s, the state elite
enjoyed a considerable degree of autonomy from societal forces in the
shaping of policy. Peasant groups, labor unions, and business
associations were all co-opted and were thus in no opposition to
challenge or bargain with bureaucrats over policy decisions (MacIntyre
1993: 154). Economic policy-making has been fairly well insulated from
pressure or lobbying by business or labor associations. An important
reason for this is that the restrictive corporatist networks of
state-dominated interest associations serve to limit and contain
demand-making by societal groups. The political position of business
has been weakened by the historically small role of the private sector
within the Indonesian economy and the fact that the bulk of the business
population is made up of Chinese Indonesians—an ethnic minority which
has long been unpopular. As a result, business people seeking
assistance from the state have traditionally made approaches on an
individual and informal basis, rather than in an organized and
group-based fashion (MacIntyre 1992: 148).
3. The Financial Liberalization in the 1980s:Uneven and Gradual Ways to
Internationalization
The HCI ended with the beginning with the economic crisis of the early
1980s. The large increase in domestic demand generated by investment in
heavy and chemical industries and the associated expansion of liquidity,
combined with a decline in export demand, resulted in a large
deterioration in Korea’s current account. The current account
registered a deficit amounting to 2.1 percent of GNP in 1978, and two
years later the deficit soared to 8.7 percent of GNP. At the same time,
the inflation rate began to accelerate due to the investment expansion
in the heavy and chemical industries. In 1980 the WPI (wholesale price
index) jumped 40 percent (Park 1994). More importantly, by 1980, the
debt-equity ratio of the 50 largest chaebol was conseveratively
estimated at 524 percent, making them highly leveraged against
bankruptcy (Woo-Cumings 1991: 170).
The Korean crisis of the early 1980s, however, was not as much serious
as the case where the government might have started more drastic
financial reforms than actually did and big business would have endured
the costs involved in them for the overall national interest. Instead
it was a temporary so that the government’s availability of capital was
not substantially reduced by the crisis and the big business groups
strongly resisted against some reforms which were harmful to their
interests imbedded in the preferential credit regime. International
bankers continued to lend money to Korea in spite of the fact that Korea
was the developing world’s second largest borrower after Brazil and
Asia’s biggest, so that even in the midst of this crisis Korea was able
to raise more than $6 billion without difficulty (Woo-Cumings 1997:70).
In addition, Korean exports began to increase from the mid-1980s due to
the recovery of global economy and the high yen after the Plaza Accord.
As a result, Korean’s current account balance as a percent of GDP
increased to 9.5 % in 1986-88 from –4.7 % in 1979-80 (Gokarn 1995:24).
Therefore, the Korean government’s way of the financial liberalization
was much more cautious and gradual approach.
Probably the more important reasons that enforce the government not to
opt drastic reform measures are the chaebols’ high leverage against
bankruptcy and their invested interests in the repressed financial
system, particularly preferential credit with low loan rates and foreign
entry into the domestic capital markets. Big business showed mixed
attitudes about financial liberalization depending on issue areas (Choi
1993: 42). On the one hand, the privatization of commercial banks and
the deregulation of entry to the banking industry were welcomed by big
business because they expected that these reforms would enhance their
control over finance capital by acquiring banking as well as
non-banking intermediaries so that they could decide investments based
on their own discretion without the government’s intervention. On the
other hand, the chaebol consistently resisted against the freeing
interest rates, the elimination of policy loans because of their
invested interests in the preferential credit regime. Big business also
objected to rapid opening to external capital movements and foreign
entry into the capital markets because of their fear that their
ownership would dilute and the exchange rate would rise (Haggard &
Maxfield 1996: 232). Therefore, big business favored a gradual
transition to the more liberalized financial system. This mixed
position of big business explains why the financial liberalization in
the 1980s was not only slow and gradual but also uneven across issue
areas.
The privatization of commercial banks began in April 1981, by 1983 all
five state-owed banks were privatized successfully. One important
consequence of the privatization of banks was that big business came to
have controlling power over not only Nationwide Commercial Banks (NCBs)
commercial banks but also nonbanking financial institutions (NBFIs) in
spite of an 8 percent ceiling on ownership of an NCB by any single
individual or family or business group. In addition, as a result of
the fact that local banks and NBFIs are not subject to ownership
limitation, most insurance companies, large investment and finance
companies, and securities firms were owned or controlled by the chaebol
(Park & Kim 1994:163). According to Fox’s (1995) analysis, of the top
commercial banks in Korea, a total of 8 banks (50 percent) are
controlled by the chaebol through family and chaebol’s financial
affiliates ownership. This has an important political implication.
Being able to control finance capital, the chaebol now could reduce the
state’s relative autonomy for directing their investments into industry
sectors the state prefers. The removing of interest rates controls and
policy loans have been extremely difficult tasks for the government
given the high indebtedness of big business and instability of financial
markets. In fact, the average borrowing cost of manufacturing rose to
18.7 and 18.4 percent in 1980 and 1981 respectively, and then fell again
to between 12.5 percent and 13.6 percent, which are not much different
from those of the 1970s (14.7 percent-11.9 percent) during the latter
part of the 1980s (Choi 1993: 50, table2.3).. Regarding policy loans,
the share of policy loans in total bank credit outstanding fell from
68.2 percent in 1980 to 62.1 percent in 1982. But the share rose again
to 67.9 percent in 1983, 69.9 percent in 1984, and 70.5 in 1985, and it
has continued to stay at this level (Choi 1993: 52). The share of loans
made to the small and medium enterprises actually declined from 45.2
percent in 1981 to 32.4 percent in 1984 (Koo & Kim1992: 143). These
facts imply that little progress was made in freeing interest rates and
reducing policy loans.
The plan for capital market liberalization announced by the government
in 1981 envisaged four phases of gradual deregulation (Park 1994).
During the first state (1981-1984), the authorities promoted indirect
investment in Korea securities by foreigners. For this, the Korea Fund
launched in New York Stock Exchange in March 1984. The second phase
(1985-87), Korean firms have been allowed to issue convertible bonds
(CBs)and bonds with warrant (BWs) in international financial markets.
By September 1988, 5 firms have issued CBs totaling $140 million, and 13
firms has issued $5.7 billion through the end of 1990. In addition, the
Korea Euro Fund was created to serve the European market in 1987. The
third phase (1987-1990), Korea’s large securities companies were allowed
to participate in syndicates underwriting foreign securities. The most
significant measures for opening capital markets were implemented during
1991-92. In 1991, foreigners were allowed to purchase listed stocks,
but only to the extent that shares had been converted from overseas
CBs. Most importantly, by 1992, foreign investors were allowed to
invest directly in the Korean stock market, albeit in accordance with a
number of restriction, including a 10 % ceiling on foreign holding in
any stock issue. The limit was raised to 12 % in December 1994 and to
15 % in July 1998 (Park and Song 1998: 212). Since 1992 foreigners have
been allowed to purchase Korean securities, but their holdings are
subjected to a predetermined ceiling of 10 percent and some issues
remain off limits. These episodes show how the government was cautious
and gradual in opening the domestic capital markets to foreigners and
big business’ interests are reflected into the government’s financial
policy.
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