South Korea’s Economy Offers Illusion of Reform

When South Korea’s economy collapsed last year and it pleaded successfully for an international bailout, the quid pro quo was to be reform.

Like its troubled neighbors in Asia, South Korea needed a dramatic transformation--away from the insular, chummy patterns that protected poor decisions by well-connected politicians and business executives.

The government was called upon to open up its markets and dismantle the powerful conglomerates whose massive overseas borrowings were blamed for triggering last year’s collapse of this once-dynamic economy.

And since then, the country has seemed the star pupil of the International Monetary Fund, winning high marks for boosting its dwindling foreign reserves to $41 billion, renegotiating $158 billion in foreign debt and passing laws designed to open up its long-protected market and toughen financial oversight.

But nine months after the election of President Kim Dae Jung on a reform platform, the changes seem to be more of form than substance.

The nation’s largest companies today have a stronger, rather than weaker, role in the South Korean economy, and the gap between the haves and have-nots has widened. The wealthy tycoons who run those firms, which are known as chaebol, have grown even richer off the high interest rates that are sending thousands of small and medium companies into bankruptcy every month.

Resistance From Corporate Interests

At all levels of the South Korean economy--from banking to privatization to labor reform--the government has been thwarted by political infighting and resistance from powerful corporate interests, labor unions and a public fearful of mounting job losses, rising prices and foreign domination.

Even in the areas where the government succeeded in revising key laws and regulations, the actual practices have changed little.

“We have beautiful laws, but the government needs to execute them,” said a frustrated Howard Lee, director of SeAh Steel Corp. “You can make an absolutely good law, but it is useless if it’s not enforced.”

The gap between South Korea’s promise and reality illustrates just how difficult it is for Asia’s governments to perform painful economic overhauls that require not just significant legal and fiscal changes but wrenching psychological readjustments as well.

Critics fear that Korea’s failure to confront these entrenched interests is accelerating a recession that is expected to cut growth by as much as 8% this year and leave 2 million people jobless.

The middle class and poor are being hit the hardest. One out of four Korean workers is delinquent on payments to banks or retailers, according to the Korea Investors Service Co. Divorce and crime rates are on the rise.

A series of recent events has undermined confidence in Kim, a longtime opposition leader elected in December whose popularity at home and abroad had given him a powerful mandate for change.

Those events include the government’s intervention last month in a nasty trade dispute at Hyundai Motor Co. and its recent aborted auction of bankrupt Kia Motors, which has prompted unhappy bidders like Ford Motor Co. to threaten legal action and finally drop out. The bankrupt firm, burdened with $5.2 billion in debt, is still operating, and the government has agreed to reschedule the auction soon.

In addition, after its earlier promises to move quickly to dismantle state-owned monopolies, the South Korean government has delayed the privatization of some lucrative industries, such as the tobacco, energy and telecommunications markets, to 2003.

$4.9-Billion Stimulus Package

Shaken by criticism, the South Korean government this month announced a massive $4.9-billion stimulus package and agreed to accelerate the infusion of $37.5 billion into the country’s ailing banks by the end of the month.

You Jong Keun, special economic advisor to the president and governor of Chollapuk province, said this “Desert Storm approach” is the country’s only hope for slowing its downward spiral.

“We must commit enough resources to win this war,” he said.

But Lee Hahn Koo, president of the Daewoo Economic Research Institute, is skeptical that even such drastic pump-priming will work. This plan is intended to make more money available to businesses and consumers at lower interest rates, but South Korea’s heavily indebted banks are reluctant to issue more loans, given the global uncertainty exacerbated by Russia’s financial collapse.

Lee also fears that the government will pull back from its reforms as soon as it encounters a backlash from increasingly antagonistic corporate and public sectors.

“The government should have pushed forward earlier even though there was resistance,” he said. “The government is looking for short-term popularity.”

Labor Agreement Stirred Optimism

Things looked much brighter in January, when a newly elected Kim was able to broker a historic agreement among management, labor and the government that was viewed as an important first step down the road to reform.

Faced with the threat of national insolvency, South Korea’s militant labor unions reluctantly agreed for the first time to support layoffs in times of severe economic stress.

In exchange, the five leading chaebol leaders pledged to dismantle their powerful empires, prune their unprofitable ventures, adopt international bookkeeping practices and use their private wealth to bolster their debt-laden firms. They represented the Samsung, Daewoo, Hyundai, LG and SK conglomerates.

That set the stage for a revision of laws in February that legalized the layoff of workers if the companies prove they are in dire economic straits.

But translating paper laws into practice has been problematic.

Chaebol leaders, struggling to stay afloat in a deteriorating global economy and angered by the government’s criticisms, have repeatedly delayed their promised restructuring plans, citing the difficulty of unraveling decades of complicated business arrangements.

In the meantime, these conglomerates have actually increased their influence in the South Korean economy because lenders are reluctant to provide money to anyone but the biggest names in South Korea.

For example, the top five chaebol accounted for 80% of the corporate bonds issued in the first seven months of the year, twice the percentage of last year.

This access to scarce capital has allowed them to outlast their smaller competitors, who are being strangled by interest rates as high as 20%. An estimated 2,000 to 3,000 small and medium companies are going out of business each month.

“The only restructuring taking place is that more of the economy will be in the hands of the chaebol,” said Henry Morris, director of IRC Ltd., an economic consulting firm in Seoul. “In five years, they will hold an even more significant piece of the Korean economic pie than today.”

Chaebol Continue to Flout Government

At the same time, a government investigation disclosed in June that desperate chaebol continue to flout the government’s efforts to pare the risky behavior that created the nation’s inflated debt, such as the common practice of cross-guarantees of loans between related firms.

Meanwhile, if the five largest chaebol follow through with their so-called Big Deal restructuring plan, which was belatedly announced two weeks ago, their financial clout could increase further, according to analysts.

Under the plan, the chaebol have tentatively agreed to merge some of their less competitive divisions in eight areas, including aerospace and chemicals. But analysts remain skeptical that the firms will significantly reduce their combined work forces or shut down excessive capacity, given the pressures to maintain jobs and boost exports.

Unless that happens, South Korea will continue to be hobbled by overproduction in key industries where there was excessive expansion during the 1980s, according to analysts.

“It’s difficult to see how these rearrangements and asset transfers will result in a reduction in industrial capacity that would stop the hemorrhaging,” Morris said.

Complaints About Strike Intervention

South Korean business leaders complain that their efforts to trim their bloated work force have been hampered by the government’s unwillingness to confront militant labor union leaders.

They are particularly unhappy about Kim’s decision to intervene in last month’s bitter 36-day strike at Hyundai after tensions between riot police and striking workers threatened to erupt in violence.

They contend that the government-brokered agreement--in which Hyundai agreed to pare the number of laid-off employees from 1,538 to 277--will embolden labor leaders and lead to more violent strikes and labor resistance.

In response to the criticism, the government sent in riot police two weeks ago and broke up an illegal strike at bankrupt Mando Machinery, a main Hyundai supplier. It is not yet clear how Mando’s labor situation will be resolved.

Labor unions, which cultivated a close relationship with Kim during his years as a dissident leader, are also losing patience with his promises to bolster the nation’s social safety net. The government has agreed that by the end of the year it will provide unemployment compensation for up to 3 million people. But overworked bureaucrats have not been able to keep up with expanding demands.

Support From Labor Leaders to Be Sought

Prominent dissident Park No He, a South Korean poet who was released last month after serving six years in prison on a subversion charge, plans to meet soon with militant labor leaders to plead for their continued support for the president, even though his reforms will lead to more pain for their members.

“I must try to convince them why Kim Dae Jung’s reforms must succeed,” he said. “But the workers are confused, angry and frustrated that the chaebol reform is so slow while the workers are made to bear the pain.”

Rehabilitation of South Korea’s debt-ridden financial sector, which is expected to cost the government at least $3.7 billion, is also moving at a snail’s pace. Banks with money are fearful of lending it out, given the uncertain future of their major customers. And weaker banks are falling further behind as their bad loans expand and they are forced to borrow more money just to stay afloat.

Richard Samuelson, director of research for SBC Warburg Dillon Read Investment in Seoul, fears that Korea is following Japan down a path that will prolong the financial crisis by forcing strong banks to take on the problems of weak ones.

In June, the government closed five commercial banks and put seven others on conditional approval. Sixteen merchant banks and four leasing companies have also closed their doors.

But the government has announced that the assets of the five shuttered commercial banks, including their employees, will be taken over by healthier South Korean banks. The merged banks are under orders to slim down, but no plans have been announced.

Samuelson said the long-delayed auction of bankrupt Korea First Bank and Seoul Bank, now scheduled for November, is likely to fail for lack of buyers. If that occurs, the government is likely to turn to other local banks for salvation.

“Most of these weaker banks don’t have any distinguishing characteristics,” he said. “There are no obvious benefits [from a merger] except, frankly, to save staff.”

Foreign Investment Is a Hopeful Sign

One bright spot for South Korea has been its success in attracting investment from overseas in recent months, in part because the devaluation of the won made assets cheaper and the government lifted restrictions on foreign ownership.

Foreign investment has increased dramatically during the first seven months of this year, to $3.7 billion. Foreign firms entering the market include Wal-Mart, Procter & Gamble, Volvo, Coca-Cola, Fuji Xerox and Seagram Co., with more than half of the foreign capital going into the manufacturing sector.

But Samuelson and others say even this is threatened by the country’s highly visible stumbles on the reform front and the global instability that has scared investors away from all emerging markets.

South Korea can’t afford to lose any of its luster abroad since its recovery is so dependent on its ability to export more products for hard currency and to attract capital. This message was reinforced last month when the country’s cost of borrowing money shot up dramatically after Russia’s economy collapsed and investors began seeking less risky ventures.

“In the end, it does not really matter what the [South Korean] government does or even what the international multilateral agencies do,” said Han Duck Soo, South Korea’s minister of trade. “The real key is the private investors. Do we have credibility with them?”

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Special Report: South Korea

* EXPORTS--As overseas sales fall, so do hopes of recovery.D1

* WAL-MART--The U.S. giant enters the Korean market.D1