Slush Fund Scandal May Help Korean Economy in Long Run : News analysis: Disclosure offers chance to break down the collusive nature of business-government ties.

South Korea’s slush fund scandal, with its indictments of seven top business tycoons, brings a short-term blow to the country’s economy--but may carry long-term benefits.

The disclosure that former President Roh Tae Woo accumulated a $653-million slush fund through bribes and political donations offers an opportunity to break down the collusive nature of business-government ties, many in Seoul say. That could build a stronger base for future growth.

Views diverge, however, on whether South Korea will ultimately carry out the structural reforms and deregulation measures needed to free up the country’s economy and undercut the institutional basis for corruption.

In the meantime, the scandal is hurting the country’s still strong but rapidly cooling economy. The stock market index has dropped nearly 8% since Roh’s confession in late October.

Economists attribute the impact mainly to concerns that the scandal may frighten the 30 top conglomerates that dominate South Korea’s economy into scaling back capital investments.

Samsung Economic Research Institute said last week that unless the slush fund investigations come to a quick conclusion, the scandal could knock South Korea’s 1996 growth rate down to 6%, from a previously forecast 7.4%. The economy in any case was already on a cooling path from this year’s projected growth rate of nearly 9.5%

Another think tank, Daewoo Research Institute, cites difficulties faced by small and medium-sized companies in borrowing money.

“Construction orders from the private sector have dropped,” said Lee Hahn Koo, president of Daewoo Research Institute. “The borrowing conditions of Korean companies and Korean banks in foreign markets have become worse than before. Some companies have already canceled their plans to mobilize funds in foreign markets.”

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The influence of the conglomerates, known in Korean as chaebol , is pervasive. The 30 largest chaebols’ total sales, including the resale of products or components produced by other companies, are equal to nearly three-quarters of South Korea’s GNP. In value-added terms, these 30 conglomerates contribute about 15% of the country’s total economic output.

“Because of this incident, we are afraid that anti-big business sentiment, which is already at a dangerous point, will spread even more among the people,” commented a business association official, speaking anonymously. “It makes us worry that in the next few years we will have trouble settling labor disputes.”

The official also expressed fear about the scandal’s impact overseas, where lenders have begun charging a “Korea premium” on interest rates that could damage the international competitiveness of South Korean firms.

He voiced hope, however, that some good might come out of the scandal.

He said top management at some chaebol believe that by spotlighting past practices, the current uproar offers “a good opportunity to restructure business-government relations and increase the productivity of business . . . They think all this so-called business wrongdoing resulted from too much government regulation.”

It is not just moral outrage, but practical necessity, that lies behind the calls for reform.

While government direction and support for the chaebols played a key role in the country’s industrialization, “the Korean economy has outgrown that now,” the business association official said. “It’s too big to be regulated by the government. The international environment also favors liberalization.”

Lee, the Daewoo Research Institute president, argues that laudable as such goals may be, many people are overly optimistic about achieving them.

“After this incident, if they do not deregulate seriously, and if they do not privatize state-owned companies, and if they do not change political fund laws, and do not change the party’s political organizations, then I don’t think we will have a different relationship between business and political circles,” he said. “Up to now there is no talk at all” of actually making specific changes on those aspects.

Lee also pointed out that top business people have been arrested in previous scandals, “but the state of corruption in South Korea did not improve, even with severe punishment.”

The reason for this is that the arrests of business leaders were not accompanied by structural change, Lee said. There is little evidence that things will be different this time, he said.

“Up to now, there is no announcement of a plan to change the institutions--only talk about morals and ethics, not the structure,” he said.

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A longtime Western businessman in Seoul, who spoke on condition of anonymity, declared flatly that reform “is not ever going to replace the fact that white envelopes are necessary in Korea. Never.”

Payments to higher officials may have been reduced but many more are now necessary to lower officials, he charged. Project approvals also are taking longer because payments have been disrupted, slowing down government action, he said.

The most visible effect of the scandal on the economy so far, according to Ahn Suk Kwo, economics professor at Hanyang University and member of a presidential economic advisory group, has been to freeze up funds flowing to the underground capital market, the most critical source of financing for small and medium-sized firms.

Although estimates vary wildly, some put the market at $25 billion, with interest rates 20% or higher compared with 14% or so at official banks.

Since the slush fund scandal broke, this so-called “curb market” has been “drastically reduced,” Ahn said. This is because the market has traditionally been supplied by those wishing to hide illicit funds--and those lenders are now lying low to avoid attention by government authorities. As a result, he said, small and medium-sized firms are facing a serious financial crunch.

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Yang Dong Ki, an analyst with Dongbang Peregrine, said that the financing problems are the latest of a series of hard knocks against South Korea’s smaller companies, including a 5% appreciation of the South Korean won against the dollar and rapidly rising wages.

“This year already, more than 13,000 companies have failed,” said Moon Seung Yong, a spokesman for the Korea Small Business Federation. “This is a crisis for small and medium-sized firms. . . . Large industries are facing criticism from the people. But the effect is felt more by us.”

Yang predicted, however, that the government will not allow the economy to sag too far because of looming National Assembly elections next year.

“If the economy deteriorates too badly, the government will give it a boost,” he said.

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Times researcher Chi Jung Nam in Seoul contributed to this report. Holley reported from Seoul and Watanabe from Tokyo.

* MAIN STORY: A1