Chaebol and Catastrophe: A New View of the Korean Business Groups and Their Role in the Financial Crisis

Robert Feenstra, Gary G. Hamilton and Eun Mie Lim
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Gary G. Hamilton: Department of Sociology Box 353340 University of Washington Seattle, WA 98195
Eun Mie Lim: Department of Sociology Box 353340 University of Washington Seattle, WA 98195

Asian Economic Papers, 2002, vol. 1, issue 2, 1-45

Abstract: We present a model of industrial organization that has multiple stable equilibria and argue that the high-concentration equilibrium describes Korea's economy and the low-concentration equilibrium describes Taiwan's economy. Past industrial policy of the state may have put Korea's economy in the high-concentration equilibrium, but discontinuation of the policy did not cause the industrial organization to change because this is an economically viable equilibrium.The high-concentration equilibrium produces a narrower range of final goods than the low-concentration equilibrium, which explains why the 1996 collapse in semiconductor prices caused the less diversified Korean economy to contract more than the more diversified Taiwanese economy. More importantly, this collapse in demand caused Korea's economy to move to a new equilibrium that has a smaller number of business groups, as evidenced by the collapse of the second-tier chaebol and their absorption into the first-tier chaebol. This wave of bankruptcies, combined with the financially precarious state of the merchant banks, created an investor panic that precipitated the crisis, which began with the 17 November 1997 devaluation of the won. This is why economic fundamentals could explain the chaebol bankruptcies before that date and not those after that date. The logic of our model suggests that public policy should focus on reducing the vertical linkages within business groups and not on reducing their horizontal linkages as the current "Big Deal" program of the government is doing. Copyright (c) 2002 Center for International Development at Harvard University and Massachusetts Institute of Technology.

Date: 2002
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