The Korean economy has been in a constant state of havoc. Recently, one of the most scarring events involves the construction of Legoland in Gangwon Province and its ill-managed finances. One poor decision came after another; what started off as an innocent plan for a children’s theme park resulted in ungovernable economic chaos. This macroeconomic domino effect has been in motion for some time now, and with troubled waters stirring the Korean financial market, the aftermath is yet to be continued.
Korea is going through a major crash in its debt market, with the Gangwon local government unable to pay back its bonds and immediate panic ensuing amongst the bondholders. Widespread worries heighten as citizens helplessly watch the debt market slowly freeze over in front of their eyes, and whether or not the government’s attempts at resolving the situation are successful remains a questionable topic.
The Debt Build Up
The unfortunate series of events began in 2011, the year Gangwon Jungdo Development Corporation (GJC) – the company founded by Gangwon Province for the purpose of building Legoland – signed a contract with major British corporation Merlin Entertainment to start construction together. Initially, the idea of a Legoland in Korea was exciting for many; yet, according to the Weekly Chosun, the contract was largely unfair, as it involved renting the Gangwon site to Merlin for 100 years without charge along with a rather unjust, restrictive profit distribution for Gangwon-do. The contract renewal in 2018 only saw degraded conditions for GJC, with many even accusing it to be a “slave contract.” Needless to say, the construction of Legoland and its monetary issues were already off to an ominous start.
In 2020, GJC established Iwon Jeil Cha, a special purpose company (SPC) that would issue bonds with a value of 205 billion Korean Won (KRW) to use as funding. When asked about the purpose of SPCs, Professor Kang Minwook (Department of Economics) explained that corporations widely form SPCs to give an initial impression of having high credit to their bondholders, while tasking SPCs with miscellaneous finance matters on the side. However, he comments, GJC’s establishment of an SPC was not the fundamental problem.
Essentially, what sparked panic was the way that the current governor of Gangwon-do, Kim Jin-tae, dealt with the situation. One day before the maturity date, which is when the bond is due, Governor Kim dropped the bomb that GJC would be starting a rehabilitation plan, contradicting widely established perceptions of the bonds’ high security and credit. For many, this announcement came out of nowhere, but it is not an overstatement to say the decision was fueled by the long ongoing disapproval Kim felt towards Former Governor Choi Moon-soon’s political and economic choices, especially what some might call his “reckless” plan to build a Legoland in Gangwon-do.
The Breakdown
From that moment, it all started going downhill. The announcement of GJC’s rehabilitation plan created widespread fear and doubt, for if bondholders could not trust a local government’s bonds, how could they trust those of private enterprises or even major corporations? Accordingly, the market soon saw a massive drop in the demand for bonds, and even with increased coupon rates, the debt market steadily froze over. Here, Professor Kang brings up the economic concept of “negative externality,” a cost suffered by a third party as the result of an economic transaction. In a hypothetical pyramid of bonds, government-issued bonds would be at the utmost top with the most credibility. However, one small choice made by Governor Kim has upended the bonds at the top of the pyramid, which in turn weighed down bonds in lower ranks, resulting in a domino effect, hence the term “negative externality.”
Considering that GJC’s bonds take up less than a mere one-thousandth of the entire South Korean debt market, the overall impact this event has had is much larger than anyone would have foreseen. Governor Kim attempted to mitigate the criticism surrounding his decision, claiming that “a rehabilitation plan does not necessarily mean a default,” and apologizing for the situation’s unintended escalation. Nonetheless, this was met with a negative response, with the Korea JoongAng Daily calling him “The Liz Truss of Korea,” and the opposition Democratic Party (DP) demanding his resignation.
On October 23, the Ministry of Strategy and Finance announced its plan to provide liquidity support in order to relieve widespread panic and prevent any further recession. Deputy Prime Minister Choo Kyung-ho promised a sum of 50 trillion KRW plus alpha. Although his plan showed some success in alleviating panic and decreasing government coupon rates, it failed to resolve the frigidity of company bonds. Following this, Gangwon-do announced an ambitious plan to repay the 205 billion KRW by December 15, but it is unclear whether they are actually capable of doing so, or are just trying to put out urgent fires.
Professor Kang explains that a continuation of the current contraction in investments could result in increased unemployment rates, which would likely aggravate the recession. A potential solution as a last resort would be the involvement of the Bank of Korea (BOK). In this case, the BOK would instead buy the corporations’ bonds in a feasible attempt to solve the aforementioned financial issues. Although this solution is not without its complications, such as the probability of succeeding inflation, Professor Kang suggests that, because the issue began with psychological effects, the implemented solutions should also employ psychological tactics, thus making efforts to ease bondholders’ sense of insecurity and panic.
The recent Legoland domino effect demonstrates how one bad decision can lead to another, especially if the people in charge make irresponsible decisions and are inconsiderate about the consequences. Many blame Governor Kim for his rash decisions, and although his announcement is what toppled the first domino, former Governor Choi is also not without his many faults. With governmental solutions failing to be of actual effect, it will take some time before anybody can determine when or how the situation will be well resolved.