Reading About Korea
I don't read the newspapers
much anymore. But the other day it seemed to me that if I wanted to participate
in the lunch-table conversation at my office, I would have to learn something
about Korea. So I clipped all the articles about Korea in the three daily
newspapers that had accumulated in my apartment over 10 days, and I read
them.
I was
greatly impressed by the volume of the reporting, the diligence of the
reporters, the number of new facts recounted every day, and the number of
experts who had been interviewed and quoted. But when I had read it all, I was
left unsatisfied. I felt I didn't know what was going on, and I thought that
many readers would have the same feeling, perhaps even more so than I did.
Perhaps I was expecting more than should have been expected or could have been
provided. I don't think so, but even if I'm wrong, it makes one wonder what all
the reporting is for.
One can read a perfectly accurate and detailed,
play-by-play description of a baseball game and still not understand what
happened unless one knows the rules of baseball and something about what is
ordinary and what extraordinary in any particular game. One has to have a
mental model of the sport into which one places the facts of a particular game
if one is to create a comprehensible story. Probably most people who read the
sports pages have such a model in mind, and the sports reporter can assume that
and not have to reiterate it.
But it is
equally probable that few people who read the daily paper, even those who read
the financial pages, have a model of the international financial system in
mind. Without that, they cannot be expected to understand the connection
between the bankruptcy of some Korean firms and the decline of the value of the
Korean currency (the won) relative to the dollar, why the Korean population in
general is suffering, why unemployment should rise, or why the trade deficit
should decline. Most importantly, they will not understand the function of the
external funds being provided by the International Monetary Fund and some
countries, or where the whole process is heading. What would the end of the
"crisis" be?
Iknow about Korea only what I read in the
papers. But I would like to illustrate what I mean by the missing model by
telling a Korea story within the context of a simple model of the international
financial system--a model I learned at school decades ago.
We start
with the proposition that in any country, the excess of domestic investment
(mainly expenditure on new plants, equipment, and housing) over domestic saving
(the part of the national income not spent on consumption, private or public)
is equal to the inflow of capital from abroad. This excess, in turn, is equal
to the excess of imports of goods and services over exports of
goods and services. This excess of imports over exports is the "current-account
deficit," a term that reporters use but rarely define.
These equalities are maintained by variations of the
exchange rate, interest rates, inflation rates, and real incomes. Thus, if
there are insufficient domestic savings to satisfy all highly profitable
investment opportunities, foreign capital will be attracted into the country.
Foreign investors will want to buy the local currency, in order to invest in
the country, and that will raise that currency's exchange value. With a higher
value of the local currency, exports from the country will be less competitive
and the export volume will decline, creating or increasing the current-account
deficit.
The
government may try to keep the value of the local currency from rising by
buying foreign currencies with it. To do that, the government will increase the
domestic money supply (in simple parlance, it will print more money). This, in
turn, will either raise real (inflation-adjusted) incomes (if domestic
production increases to meet the increased buying power of citizens), or raise
the price level (if more money ends up chasing the same amount of goods).
Either of these effects will attract imports and discourage exports, increasing
the current-account deficit. Rising real incomes enable citizens to buy more
imports and more of the domestic product that would have been exported, or
attract domestic resources into producing for the home market rather than for
export. A rising price level will make the country's exports less
competitive.
Before the crisis, in 1996, Korea had an
extremely high rate of domestic saving--about 35 percent of total Korean
income, compared with about 16 percent for the United States. But it had an
even higher rate of internal investment, thanks to an inflow of foreign
capital. So large was that inflow that Korea ran a current-account deficit
equal to almost 5 percent of gross domestic product, higher than in any other
industrialized country except Poland and the Czech Republic. As noted above,
this deficit was made possible by a high exchange rate for the won. The
exchange rate would have been higher, and the deficit larger, if the government
had not been buying dollars with won, and in the process accumulating a reserve
of dollars.
Toward
the end of 1997, investment in Korea suddenly became less attractive to both
Korean savers and foreigners. A number of Korean businesses went bankrupt,
either because of dishonest practices or because the possible Korean share of
world markets for some products, like automobiles, had been overestimated.
Foreigners wanted not only to stop investing in Korea but also to get their
money out. The effort to convert won into dollars and other foreign currencies
depressed the value of the won, despite the Korean government's efforts to
sustain it by using its reserves. The decline in the won caused further
bankruptcies. Companies that could pay their foreign debts when a dollar cost
900 won could not pay when a dollar cost 1,400 won.
The decline in the won, by making imports more expensive
and exports more competitive, would help bring about the decline in the
current-account deficit, or the generation of a surplus. So, one could
visualize a postcrisis situation in which total output was unaffected;
investment was smaller; the capital inflow was smaller or negative; and the won
would reach an equilibrium level, lower than it had been before the crisis.
But the
transition to that situation would be painful. The decline in the won would not
immediately raise exports or limit imports. The cut in output and employment in
the investment sector would not be immediately offset by a rise in output and
employment in industries that produce for export or that compete with imports.
The decline of the Korean economy would cause more bankruptcies, increase
investors' efforts to get out of won assets into other currencies, and force
the won down further. So there could be a cumulative, speculative process in
which the won fell far below what might be its long-term equilibrium value and
the Korean economy was depressed far beyond what its postcrisis situation would
be.
The purpose of assistance by the IMF and
foreign governments is to cushion that transition and help Korea get to its
postcrisis condition. The objective is to keep the won from falling much more
than is necessary for the long-run adjustment of the Korean economy, and
thereby to prevent unnecessary bankruptcies and unnecessary depression of
Korean income and employment. The goal is not to bail out failing Korean
enterprises but to keep enterprises from failing only because of a panicky
flight from the won and the fall in its value. The assumption is that private
investors who buy and sell won are depressing its value below its equilibrium
rate. That assumption may or may not be correct.
This may not be the only
possible story of the Korean economy. But it is a story that fits into standard
economic analysis, is coherent and understandable, and reveals the interaction
among the forces at work--the kind of story I miss when I read the daily
reports.
