Regulatory Forbearance and Financial Crisis in South Korea

Abstract

Since the outbreak of the so-called currency crisis of Korea in 1997, many theorists, policymakers, and practitioners have provided several accounts of the crisis, pointing to issues such as soft-budget constraints of the government, the moral hazard of financial intermediaries, and inefficient corporate governance structure. Though these analyses have explained some aspects of the crisis, they have rarely stressed the role and impact of government regulations on the national economy. Prior to the crisis, Korean government interventions in market activities through various industrial policies were regarded as one of the most important bases of the rapid economic growth that lasted for more than 30 years, creating a collaborative but collusive relationship with the private sector. This close governmentbusiness interconnectedness implies that a study on the success or failure in the economy provides only a partial explanation if it does not pay attention to the behaviors and institutional structures of the government that make and implement regulatory policies. This paper argues that government failures that arose from regulatory forbearance were one of the most significant underlying causes of the crisis. Examining government regulation is particularly important because the government plays a pivotal role even in a time of crisis, as well as in the currently ongoing reform process. Critics argue that the government should step down from the reform process, leaving the market more options to choose its own survival path. This viewpoint is based on the notion that the