A turnaround in South Korea

Print edition : July 17, 1999

The speed of South Korea's economic recovery has been impressive and almost unique in the contemporary world.

IN the last week of November 1997, news broke in the world media that the Republic of Korea (South Korea in common usage) had approached the International Monetary Fund (IMF) for assistance in order to escape an external payments crisis and a possible debt default. By then the usable foreign exchange reserves of the country had come down to $7 billion to 8 billion, although official statistics still showed the foreign exchange reserves to be $24 billion. Most of this amount had been given by the central bank to the domestic banks to support the operations of their branches overseas. The usable foreign exchange reserves were down to a value of about two weeks' imports. Moreover, the total external debt of the country was $180 billion, of which short-term debt came to $100 billion.

The rescue package organised by the IMF came to $58 billion; of this, $21 billion was the loan pledged by the IMF, the largest amount to be lent to any country in a single deal. The rest of the $58 billion was composed of loans to be granted by the World Bank, the Asian Development Bank, the Japanese government and so on.

By the beginning of May 1999, that is, within a year and a half of seeking IMF assistance, South Korea's usable foreign exchange reserves had risen to $56 billion, and a severe economic downturn in 1998 had been converted into an expected rate of growth of 2-4 per cent this year. South Korea has been the first of the East Asian and South-East Asian countries to emerge out of the economic crisis that broke out in the wake of Thailand's forced devaluation of its currency in July 1997. Thereby it has confounded both the critics and the supporters of the IMF's package of policies, and the critics of the irremediable structural faults from which South Korea was supposed to suffer.

This does not mean that South Korea will necessarily be able to resume the high-growth path trajectory which it had recorded for almost 30 years before the downturn of 1997, nor that it will be able to get rid anytime soon of the enormous increase in unemployment that has accompanied the structural adjustment programme. In the boom years between 1990 and 1995, South Korea had attained virtually full employment (the rate of unemployment was 2 per cent in 1995) and there were an estimated 1,68,000 legal and illegal immigrants in the country by the second quarter of 1996. By May 1999, the official rate of unemployment was 8 per cent, and if we take into account the 'disappointed' who had given up looking for jobs, the rate goes up to 10 per cent.

Much of that unemployment is structural, in the sense that the unemployed are mostly easily retrenchable female labour or low-skilled male labour. This labour is unlikely to find jobs easily even when growth is resumed, since many of the low-skill jobs or 'jobs fit for women' under this South Korean patriarchy will be reorganised out of the system in the current process of restructuring.

Since 1996, South Korea has been a member of the Organisation for Economic Cooperation and Development (OECD), the only Asian country other than Japan to be accepted into that exclusive club. It may have to share the fate of carrying a large load of structural unemployment even in times of relative prosperity. However, South Korea differs from most other OECD countries in one major respect: it has very little social insurance for the unemployed.

With all these problems characteristic of a full-fledged capitalist economy without the protection afforded by a welfare state apparatus, South Korea's speed of recovery still remains impressive - almost unique in the contemporary world. How does one understand this performance? And why did South Korea get into the mess of an external payments crisis in 1997?

IN most of the literature analysing the crisis and its aftermath in South Korea, one signal aspect of the society and policy in the country has barely been mentioned, namely, its geopolitical and geomilitary situation. It is a relatively small nation situated at the geopolitical confluence of three large and powerful countries, namely, Russia, China and Japan. Moreover, it was until 1910 an independent nation that had successfully resisted Japanese attempts to conquer it and had also remained independent of the Chinese empire to its south and east. It had remained under direct foreign rule only for the 35 years between 1910 and 1945, and the Korean people and their leaders on both sides of the border dividing North Korea and South Korea remained fiercely conscious of their historically independent status as a nation.

Even when North Korea and South Korea fought a bloody civil war (1950-1953), and the South Korean regime was preserved only through the intervention of the United States and its allies, and a U.S. Army contingent was stationed permanently on Korean soil, South Korea did not become just a passive dependency of the U.S. Syngman Rhee, who was President of South Korea during the 1950s, repeatedly flouted the advice of U.S. advisers and pursued a strategy of building up Korean industry through a policy of import substitution rather than allowing South Korea to slide back into the role of a supplier of rice and seaweed to Japan as it had been under Japanese rule.

Park Chung Hee became President in 1961 through a military coup and fashioned the economic strategy that lifted South Korea out of poverty and converted it into one of the fastest growing economies in the world. He had been trained in the Japanese military academy and modelled his economic strategy on that of Japan rather than following the dictates of static comparative advantage according to the advice tendered by Western policy advisers. He was conscious of the abject dependence of his regime on U.S. military and economic aid. One prong of his strategy was to lessen the degree of that dependence. For this purpose, he sought a rapprochement with Japan, the traditional enemy. This opened up another avenue of economic aid, a nearby large market for Korean products and a source of modern technology, equipment and managerial expertise. The drive to earn much larger amounts of foreign exchange by boosting the growth of exports was motivated both by the goals of generating more income and employment and loosening the foreign exchange constraint on investment and economic growth.

In a shopping area in Seoul, the modern South Korean capital.-

The central institutional mechanism for driving the nationalist but foreign-aid dependent engine of growth was a military command system. In an analogy with the Japanese system of national economic management, which has been called Japan Incorporated (Inc.), the Korean system has also been styled as Korea Inc. But the proper analogy for the system under the regime of Park Chung Hee is the supreme General Headquarters (GHQ) of an army during a military campaign.

The abolition of landlordism in South Korea had destroyed possible bases for the use of private violence. (In this respect the country differed profoundly from India, from the 1950s.) General Park, who became President Park, monopolised the public means of coercion and compulsion. All adult males between certain ages were subject to compulsory military service. The system still prevails. The family structure remained patriarchal, and women were subordinated to men in most areas of decision-making. But unlike the situation in many communities in South Asia, or most countries in West Asia, there was no stigma attached to women working for a wage.

As the rate of economic growth accelerated and agriculture ceased to provide work for the majority of the workforce, more and more women were inducted into the labour force. However, the majority of the entrants into the labour force were young women up to the age of 25 or thereabouts, and many of them went out of paid employment as they married and raised children, since men were not expected to shoulder any part of the burden of housework. Between the 1960s and 1982 the share of manufacturing in total employment rose from 10-12 per cent to more than 20 per cent, and the participation rate of female labour rose from about 36 per cent to more than 40 per cent. By 1995 this rate had gone up to 47 per cent.

South Korea put emphasis on educating its workforce in as good a manner as possible, both through public programmes and through the sustenance of appropriate private incentives. The educational levels of women rose along with those of men, though at a slower pace. By now virtually all the adult males and females are literate, and a large proportion of the population has undergone secondary and university education.

Real wages of South Korean workers rose seven-fold between the late 1960s and 1997, when the crisis broke out. However, in spite of these advances, South Korea recorded perhaps the largest male-female differentials in wages worldwide: a woman at any level of education earned barely half or a little more of the pay of her male colleagues. What is equally striking is that very few women can be found in a decision-making position in any large-scale organisation or business.

Business in South Korea is conducted on a patrimonial basis, to an even greater degree than in India. The heads of the big chaebols (the conglomerate business groups) are men and their successors are their sons, brothers or cousins. One of the objectives of reform after the recent turmoil is to change the style of governance of these chaebols. But this is not going to be an easy task: chaebols were deliberately encouraged during the Park regime as instruments of the government's policy of promoting industry and penetrating export markets.

The government controlled both the domestic deposit-money banks and the allocation of foreign exchange. Both domestic credit and foreign exchange receipts (whether in the form of export earnings, military or economic assistance or loans from foreign sources, mainly the U.S. and allied governments and financial institutions controlled by them) were channelled to designated objectives of production and exports to be attained by the favoured conglomerates.

After Park's assassination, the chaebols came to influence government policy in their own interest, especially under the military-authoritarian regime of Chun Doo Hwan (1980-88). After the eruption of a movement for democracy supported by militant workers and students in 1987, attempts were made to reform the working of the chaebols and mitigate their concentration of economic power, which had reached one of the highest levels in the world. There was a lull in the growth of the economic power of the chaebols in the late 1980s, partly because of a slowdown in economic growth. But in the 1990s, the economic boom chiefly powered by large-scale domestic and foreign borrowing led to their further growth, until the economic crisis, which began in 1996, led to bankruptcies of some of the leading chaebols, such as Kia and Hanbo.

South Korean enterprises, as in the case of most large Indian firms, are characterised by high ratios of debt to equity. In fact, it has been claimed by Robert Wade and other radical critics of the policy enforced by the IMF that high debt-to-equity rates are characteristic of the high-growth Asian economies, and that trying to bring down these ratios and make them conform to the Anglo-American ideal of debt-equity ratios of 1:1 or lower figures is to strike at the prime financial lever of Asian growth.

There is certainly a great deal of truth in this proposition. Stock markets in many of these countries play a minor role compared with banks and other money market institutions in mobilising national savings. Insulating the operation of a company from the short-term fluctuations of a fickle stock market (which as often reflects unfounded speculator sentiments as it reflects the fundamentals of the performance of a company or the economy in which it operates) allows the controllers of the company to pursue long-term goals of productivity growth through expansion in scale and scope, and through in-house learning and implicit or explicit research and development activities.

The trouble in South Korea during the expansive phase of the 1990s was that not only were debt-equity ratios high, they kept on rising, even down to 1998. According to an estimate made by Seong Min Yoo, the debt-equity ratio of the top 30 chaebols was 4.21 in 1989, 4.49 in 1997 and 6.03 in 1998. The close relationship between the government and businesses under a military or semi-authoritarian regime (as that of President Roh Tae Woo) led to corruption, and big firms were often able to get approvals of risky investments by influencing government or bank officials.

Outside the Hyundai automobile plant in Ulsan, South Korea, in July 1998, a demonstration against the company's restructuring plan.-KIM KYUNG-WOO/REUTERS

Hanbo Steel, for example, had an equity base of 90 billion won but was able to borrow 2,700 billion won to build the steel mill, giving it a debt-equity ratio of 30 to 1. It went bankrupt in January 1997, with a debt of 5,000 billion won, the largest case of bankruptcy in the history of the country. Eventually the Hanbo group itself collapsed. By the end of 1998, altogether 16 groups, which had been classed among the top 30 chaebols were bankrupt or were undergoing restructuring under government, bank or court directives. Many other smaller chaebols were also undergoing such a restructuring process.

However, despite government resolutions to remodel the style of corporate governance, the chaebols are not about to disappear, not even about to play a less significant role in the running of the South Korean economy. Soon after the agreement with the IMF was signed, the South Korean government took over the debts and the management of the Korea First Bank and the Bank of Seoul. The operations of the merchant banks, which had been mainly responsible for running up the short-term debt, were suspended, and a new supervisory authority, independent of the central bank, was created to oversee the operations of all financial institutions. As a result of all these measures of tightening credit, many more firms went bankrupt in 1998 than in 1997. The number of insolvent firms rose from 9,502 in 1993 to 17,168 in 1997 and to 21,966 in 1998. But significantly enough, most of the cases of bankruptcy in 1998 occurred early in the year, and the rate of failure of firms came down drastically in the latter part of the year.

The chaebols were urged to engage in the 'Big Deal', that is, exchange some of their assets with one another, so as to streamline their clutch of enterprises and concentrate on their areas of core competence. In October 1998, the five top chaebols, namely, Samsung, Hyundai, Daewoo, LG and SK, announced that seven of their business divisions - dealing with semiconductors, petrochemicals, oil refining, aviation, railway rolling stock, power generation and engines for ships - would be restructured following the strategy of the Big Deal.

This will have three effects: (a) increase the sizes of the companies in each sector and make them formidable penetrators of export markets (b) keep out foreign enterprises seeking to buy up weak firms at cheap rates and (c) minimise or eliminate domestic price competition among rival firms.

Thus, for example, Hyundai Electronics and LG Semicon agreed to set up a company which will rank second only to Samsung Electronics, that has been the world leader in the manufacture of semiconductors for some time. The takeover of the automobile business of Kia and Samsung Motors by Hyundai has converted Hyundai Motor into one of the top 10 automobile manufacturers in the world. Its only rival in the country is Daewoo Motor, which has taken over Ssangyong Motors. Both the companies have the ambition to emerge as top players in the global automobile market.

A group of South Korean women fill out application forms at an employment fair organised by the government.-AHN YOUNG-JOON/ AP

When the South Korean economic crisis occurred, there were fears of the fire sale of enterprises, particularly with foreign transnationals taking advantage of the weak won and the mountain of debt of the enterprises to buy up hundreds of enterprises and properties at cheap rates. The government also publicly encouraged foreign direct investment (FDI) as a way of acquiring more foreign exchange and keeping up the competitiveness of the domestic firms. The first half of 1998 seemed to justify the fears of a wholesale transnational takeover of South Korean firms; Procter & Gamble of the U.S. took over Ssangyong Paper Co., Coca-Cola bought out the beverage business of Oriental Brewery Co., its partner in a joint venture, Fuji Xerox of Japan bought up its subsidiary Korea Xerox, Pfizer of the U.S. bought up the stake in the pharmaceuticals business of the Shinwon group, and so on.

According to a survey conducted by the Ministry of Finance and Economy, between November-December 1997 and the first quarter of 1999, foreign capital acquired a stake in 600 enterprises, and 70 per cent of the firms were entirely turned over to foreign ownership and control. Of the total $10.8-billion FDI, only 20 per cent was intended for new businesses and the rest was for acquiring stakes in South Korean enterprises.

However, despite these figures, we have to reckon with the sheer size of the chaebols and other South Korean firms, and the resistance that has been increasingly mounted against the foreign takeover of domestic business. In 1998, the Daewoo, Samsung and Hyundai corporations (they do not include all the enterprises of the groups) each achieved sales of more than 34 trillion won, that is, taking a U.S. dollar as being equal to 1,200 won, a little below or above $30 billion each. Samsung Electronics achieved sales of 20 trillion won; LG International, 19 trillion won; Daewoo Heavy Industries, 6 trillion won, and so on. Pohang Iron and Steel and Korea Electric Power Corpo., both highly profitable state enterprises incidentally, had sales of 11 trillion and 14 trillion won respectively. It would have been difficult for transnational companies to buy up a major chunk of these enterprises, even at fire sale prices.

As it happened, after the agreement with the IMF had been signed and a minimum level of foreign exchange reserves ensured, South Korean enterprises drove into the export markets with renewed vigour. The government made special credit lines available to exporting firms, and especially to small and medium enterprises (large enterprises always had favoured credit allocations for export), and imports were cut down drastically. (The decline in the number of cases of bankruptcies in the latter part of 1998 is explained partly by these measures.) There was a 30 per cent increase in export volume but because of the depreciation of the won and weak markets for South Korean products (virtually all manufactures), export values declined. However, imports declined by almost 36 per cent and South Korea ended 1998 with a current account surplus of $40 billion and with usable foreign exchange reserves of about $50 billion. The freeze on nominal wages with a high inflation rate also drove down real wages and labour costs, as did large-scale retrenchment of workers.

As these developments took place, South Koreans became less and less willing to sell their enterprises to foreigners. Most of the proposed transfers of state-controlled financial and other enterprises to foreign firms were stalled. For example, after months of negotiation, the deal to transfer the ownership of Korea First Bank to Newbridge Capital of the U.S. fell through in the beginning of May this year.

In actual fact, there has been little let-up in the aggressive drive by the Korean firms to penetrate foreign markets as evidenced by the expansion plans of the Daewoo, Hyundai and LG groups in various sectors of the Indian market. To an uninitiated foreigner, there is something paradoxical in this seeming ability of South Korean enterprises to ignore the impact of hard times. The results of virtually all the chaebols in 1998 show up huge losses: for example, the losses of the Hyundai, Ssangyong, Hanwha and Dong-Ha groups during 1998 were reported to be (in won) 9,410 billion, 1,056.5 billion, 168.8 billion and 1,455 billion respectively. Some top groups such as Daewoo, Samsung, LG and SK showed positive profits but a recalculation, after taking into account losses covered by transactions between group companies (carried out by a local securities firm, Shinhan Securities Co.) found all of them making losses in overall terms. This recalculation showed the total losses of the top 26 chaebols as 14 trillion won, that is, considerably more than $1 billion.

On top of this, South Korean companies had piled up very large debts. The total assets of the 440 companies listed on the Korea Stock Exchange increased from $84.5 billion to $110 billion but their total debts remained virtually the same, at $278 billion.

The secret of all these developments lies in the ability of South Korean firms to obtain credit for expansion even when they were making losses. One of the main reasons for South Korea piling up so much short-term debt before the crisis was that South Korean banks and other overseas branches were extending lines of credit to South Korean firms operating overseas, even as the former were borrowing from other banks. While the present government would perhaps want to bring down the power of the top chaebols, given the way Korea Inc. can be converted into Korea GHQ in moments of crisis, and given the fact that the external payments crisis has been overcome, there are few grounds for optimism that the fundamental style of management of South Korean firms and enterprises - patrimonial, authority-centred, consensual at the top and repressive towards labour and women, especially in times of trouble - will change in the near future.

Amiya Kumar Bagchi is RBI Professor of Economics at the Centre for Studies in Social Sciences, Calcutta.

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