The past century has been a tumultuous one for the Korean peninsula. Japan gained control in 1910 and administered the land as a colony. Korea was liberated in August 1945, at the end of World War II, but two separate states were formed. The northern section was aligned with the Soviet Union, while the south was under U.S. tutelage. In June 1950, North Korea (People's Democratic Republic of Korea) launched an all-out attack on South Korea (Republic of Korea) across the 38th parallel.

The resulting three-year Korean War ended in an armistice agreement establishing the Demilitarized Zone (DMZ) that now divides the peninsula. Throughout the 1950s, South Korea survived mainly on its agricultural products and foreign aid. Industrialization started in January 1962 with the five-year economic development plan initiated by President Park Chung Hee, who had come to power through a coup in May 1961.

South Korea pursued a bureaucrat-guided, export-oriented, and capital- managed growth strategy. This approach worked well for its high-saving and hardworking people. From 1980 until 1996, South Korea achieved an average annual growth rate of 9 percent. Per capita GNP jumped from $87 in 1962 to $10,543 in 1996. In the same period, GNP increased from less than $4 billion to $480 billion, while trade volume increased from $0.5 billion to $280 billion.

In 1996, South Korea ranked second in the world in shipbuilding, third in semiconductor manufacturing, fifth in automotive, and sixth in steel production. Its economy, like those of other East Asian countries, had led the world in growth. Due to this remarkable performance, South Korea was admitted to the Organization for Economic Cooperation and Development (OECD) in December 1996.

The IMF bailout

Such a high-growth economy, tightly controlled by the government, inevitably was plagued by structural problems. Although Korea had gradually liberalized and opened its industrial sectors, bureaucrats regulated and allocated the capital flow to protect strategic sectors from foreign competition. Crony capitalism and moral hazard were ubiquitous.

The "too-big-to-fail" doctrine was considered normal. Korean conglomerates focused on reckless expansion rather than profits. Investment efficiency decreased, while investment volume increased, which spawned overcapacity. The top five chaebols (large conglomerates) controlled over 30 percent of total domestic loans, and the top 30 chaebols' average debt-to-equity ratio was over 500 percent at the end of 1997. Korean financial institutions lacked project-evaluation ability. They rashly borrowed foreign short-term credit and poured it into unprofitable long-term projects of conglomerates.

Regulation and supervision of the banking system were lax. As a result, the current account deficit continuously piled up and external debts were increasing. In 1996, Korea's current account deficit amounted to $23 billion, 4.9 percent of GDP, and external debts totaled $164 billion at the end of 1996. The crisis was just around the corner.

In 1997, the economy turned gloomy. Its growth rate slowed, and exports lost strength. A string of chaebols--such as Hanbo, Sammi, Jinro, Haitai, and Kia--fell into bankruptcy. The Asian economic crisis, triggered by the floating of the Thai baht on July 4, 1997, spread to Malaysia, Indonesia, and Korea. Foreign short-term money had contributed to the "Asian Miracle" by supplying abundant capital; in return, foreign investors enjoyed high profits. When they suddenly realized that the Asian economic instability was worsening, they stampeded to the exit.

South Korea's usable foreign exchange reserves were $22.5 billion on November 1, 1997, but dwindled to just $6 billion on December 2, 1997. The next day, the International Monetary Fund (IMF) bailout program of $58.2 billion was announced. The initial rescue plan failed to stem the outflow of short-term capital. …