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Working Paper
The Change of the Financial System and Developmental State in Korea
This study examines the role of institutions and their change related to the rapid economic development and the 1997 Korean financial crisis. In Korea, the government built a state-led financial system through the 1960s and 1970s and a specific government-bank-business relationship based on it. It promoted economic growth by allocating financial resources controlled by it to targeted industries or firms, with discipline over business achieved through these institutions. However, as the economy developed, this financial system and the relationship between the government and business changed. While the government's control of finance weakened, the economic power of chaebols grew stronger, and their relationship changed from dominance and discipline with co-operation to regulation and conflicts. Accordingly, former institutions could not work well, but there was no proper reformulation of them and they failed to evolve to match these changes. The banks failed to monitor business and the problems in banks and chaebols, including the bad corporate governance, grew serious. Subsequently, the rapid and incautious financial liberalization with these problems led the Korean economy into economic crisis in 1997. Institutional reforms and new institution building are urgently required, but must be adopted under
adverse circumstances.