[NOTEBOOK]Government Must Learn to Cut Losses

There is a man who loses significant sums of money unusually frequently when he is gambling. He doesn't know when to stop and raises the stakes even when he has a bad hand. This short-sighted, desperate attempt to recover his losses in a short time is the main factor contributing to his defeat.

This phenomenon, whereby people or organizations continue to invest resources in failing courses of action, is called an escalation of commitment. Governments can demonstrate even stronger tendencies than individuals to stick to bad courses of action. In 1997, just before the financial crisis, the government drained its foreign reserves to defend the exchange rate of the won, which was pegged to the dollar at that time. After the government had decided to defend the exchange rate, it could not alter this decision or turn to alternative courses for fear of acknowledging its failure. As a result, Korea's foreign reserves fell to just $3.9 billion from $33.5 billion. The same applies to the Daewoo Group, where banks and creditors missed their chance to tackle the problems effectively by insisting on sticking to the wrong decision. Since last May, the amount of money which creditors have sunk into or have committed to sink into the Hyundai affiliates tops 12 trillion won ($9 billion). Since the Finance and Economy minister, the Financial Supervisory Commission chairman and presidential economic secretary decided to bail out Hyundai Engineering and Construction Co. with 250 billion won, they seem to have been trapped by their own initiatives.

Why do people insist on pursuing bad decisions? First, there is a tendency regardless of the individual or organization to justify the errors made in the past by obstinately sticking to them.

Second, putting the utmost priority on consistency may lead to misjudgment. When a decision turns out to be misguided, alternatives should be sought immediately. It is foolish to insist on following the wrong path when there is no hope.

Third, an obscure expectation based on erroneous probability calculations that the situation will remedy itself in just a little more time also leads people to insist on bad decisions.

Fourth, an escalation of commitment prevails when the person who made the wrong decision still holds power. He sticks to his decision because his authority may be hurt if he acknowledges his errors.

We must consider whether an unwarranted escalation of commitment has been the driving force behind the sinking of 13 trillion won of public funds in total in the financial sector and in corporations since the economic crisis. At the beginning of the 1990s, when the Japanese economy showed signs of stagnation, the government there poured 110 trillion yen ($825 billion) into the problem over 10 years to try to save it. But this approach bore no fruit and ended up aggravating insolvency in the financial sector. This should serve as a grave lesson to Korea. A consistent policy should only be maintained when it is based on the right decision.

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The writer is the deputy industrial news editor of the JoongAng Ilbo.

by Lee Jong-tae