A Comparative Analysis of Financial Liberalization in Korea and Taiwan through Path Dependence

Abstract

Korea and Taiwan are regarded as typical examples of developmental states. Both countries experienced rapid growth under authoritarian regimes and have continued sustainable development after their transitions to democratic rule in the late 1980s.

The 1997 East Asian financial crisis, however, had strikingly differing effects on Korea and Taiwan. In Korea the press of investors seeking to withdraw their capital created unsustainable pressure on foreign exchange reserves, forcing the Korean government to allow a drastic devaluation of the won and to seek the support of the International Monetary Fund (IMF). In contrast, Taiwan initially appeared to have escaped the East Asian contagion largely unscathed. Its currency underwent a most and orderly decline of about 17 percent from the end of 1996 to the end of 1998. No major Taiwanese banks or manufacturing companies collapsed. And although the growth of Taiwans economy slowed in 1998, it recorded a gain of just under 5 percent, second only to China in East Asia and still one of the worlds stellar growth performance.

As a matter of fact, the Asian financial crisis was mainly caused by mismanaged financial liberalization and financial market panic in the region. Interestingly, there are salient differences in financial liberalization in the late 1980s and 1990s between the two countries. Financial liberalization in Korea was rapid, reckless and ill-designed, effectively sidelining the traditional capacities of the state to intervene strategically in the economy. Liberalization was also accompanied by the build-up of massive amounts of short-term foreign debt, over-investment in critical export industries, and a debt-riddled banking sector, eventually culminating in near financial meltdown. In Taiwan, on the other hand, financial liberalization was a far more cautious and considered affair, and was carried out in conjunction with the maintenance, and sometimes the enhancement, of the states capacity to strategically intervene in the economy to promote financial stability and economic growth.

Then, why did these two nations pursue different approaches to financial liberalization? This study intends to analyze the reasons for divergent paths to financial liberalization in Korea and Taiwan through the lens of historical institutionalism. The main argument of this study is that divergent paths to financial liberalization in Korea and Taiwan can be well explained by historically constituted unique institutions and different state-business relations in both countries.

The case studies of Korea and Taiwan show that unique historical experience exerts a great influence on the early stage of institutional formation in a significant way. And once institutions are formed, they are developed by repeated historical experience on the historical path. Later, policy makers freedom to maneuver is constrained by the historically constituted institutions. For instance, the early formation process of a capitalist class during the 1950s, constrained by historical experience, different industrialization strategies in 1960s and 1970s, and the legacies of markedly different approaches to capital allocation and government-business relations continued to exert a profound influence on the countries developmental trajectories and financial liberalization process in the 1980s and the 1990s.