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The Chinese government has ordered 39 buildings on China Evergrande Group’s manmade Ocean Flower Island in Danzhou, Hainan Province, shown here, be demolished. (Reuters)

The stories about COVID-19 that had dominated headlines until recently have been replaced by ones about inflation. Concern over high prices has been growing as the prices of oil and raw materials rise steeply along with labor costs. Many countries that increased liquidity to stabilize prices in the course of overcoming the COVID-19 crisis are now tightening their monetary supply and rapidly raising key interest rates. The US Federal Reserve decided to maintain its benchmark rate at 0.75%-1% after raising it by 0.25 points in March and by 0.5 points in May. Korea’s central bank, too, has hiked the rate from 0.5% to 1.75%, raising it five times in 0.25-percentage point increments since August 2021.

Some experts worry that this strategy of raising the key rate to curb inflation will hobble the economy due to high levels of existing debt and interest owed. Others think these worries are overblown since household and corporate debt are compensated, for example, by a greater number of assets or an increase in scale.

But for two years over the course of the COVID-19 pandemic, debt grew exponentially. Chinese officials were worried that corporate debt might affect the economy from before the pandemic started. In the case of Korea, the International Monetary Fund has warned that high levels of rapidly growing household debt could burst the economic bubble. Meanwhile, advanced economies like the US and Japan are worried about the increase in government debt.

Looking back on Korea’s economic growth, in the 1960s, the main economic activity was light industry, consisting of manufacturing shoes, fabric, and food products, whereas in the 1980s and after, it was heavy and chemical industries centered on shipbuilding, cars, machinery, and steel. Capital and technology levels were low, so Korea secured loans from foreign countries and imported technology or brought in manufacturing plants. These partnerships suited advanced countries like the US and Japan because they could enjoy high profits from low capital investment including low labor costs.

In the 1980s, Korea passed through a period of high annual average economic growth at 8.9% in the 1980s and continued to enjoy high numbers at an annual average of 8.4% in the 1990s prior to the Asian financial crisis. In the latter half of the 1990s, however, the cost of labor and raw materials rose precipitously, making it difficult for companies to maintain high profit levels.

When labor costs rise, companies must turn to technology to increase productivity and maintain competitiveness, but this is not what companies did at the time. Because it was difficult to make immediate improvements in technology, companies pursued a management strategy of diversification and grew their debt. Their main businesses weren’t pulling in profits, so they dabbled in anything that could make money. When the foreign exchange crisis erupted in 1997, it was sometimes blamed on this policy of octopus-like conglomerates extending their tentacles into other industries.

Corporate debt levels, which had stood at only 70% of GDP in 1989, rose to 80% in 1992, 95% in 1996, and ultimately 108.5% in 1998. In the course of overcoming the financial crisis, companies that vied for top ranking like Daewoo, Samsung, and Hyundai went through restructuring, reducing the corporate debt to GDP ratio to 74.1% by 2005.

China has sustained high growth since the 1990s, serving as a major global manufacturing base predicated on low wages and business costs. It achieved an annual average growth rate of 10% for a 20-year period from 1991 until 2010. Even the 1997 Asian financial crisis and 2008 US financial crisis affected this growth rate only slightly.

In their book “Saving Time,” engineering professors from Seoul National University emphasize that innovation in fields such as shipbuilding, machinery, and semiconductors requires a sustained period of trial and error. They observe that China may have overcome the conventional limitations of time by virtue of its ability to conduct countless trials in a short time due to its large swathes of territory.

There is no denying China’s technological excellence. But even as China has been the center of manufacturing for major countries worldwide, wages there have risen sharply and other expenses such as real estate have increased, prompting companies to move their production bases to Southeast Asian countries like India, Vietnam and Indonesia.

Corporate debt has also risen sharply there. After the US financial crisis in 2008, China followed a policy of economic growth through corporate investment, raising its debt to GDP ratio from 94.3% in 1997 to 117.8% in 2010 and approaching 160% in 2016. As a result, the Chinese government restructured traditional industries such as steel and coal to reduce debt and increase efficiency, and this policy worked, with the ratio of corporate debt to GDP falling to 149.1%. With the loosening of credit during the pandemic, though, corporate debt surged back to 160.8% in 2020. China accounted for nearly 30% of global corporate debt by the end of that year.

Considering that labor costs and real estate prices have risen so steeply, some believe that large numbers of companies will have to go through restructuring due to poor efficiency unless productivity increases. China Evergrande Group, the country’s second-largest real estate developer, suffered bankruptcy in 2021, and Tsinghua Unigroup, China’s leading chipmaker, is suffering from an overwhelming amount of debt accumulated during an acquisition and merger process. According to the Wall Street Journal, China has invested at least US$2.3 billion over the past three years to create a cutting-edge semiconductor company to rival Samsung Electronics and Taiwan Semiconductor Manufacturing Company, but to no avail.

Whereas major countries around the world have raised interest rates over fears of inflation, China has instead lowered preferential lending rates three times since December 2021. Their companies’ problems with excessive debt could lead to investment contraction and job insecurity, so authorities are doing their best to ensure a soft landing. If Chinese corporate debt troubles lead to large-scale restructuring, the economy will be reeling — not only China but worldwide as well. Now is the time to watch and see if China will suffer its own version of what is popularly known in Korea as “the IMF crisis.”

By Kim Yong, finance expert

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