A Nation’s Moment of Truth

This country was the model student of the International Monetary Fund, praised around the world for bouncing back so quickly from the Asian economic crisis of 1997. Now it is in danger of flunking out of school.

The reason can be divined here at Hanbo Iron & Steel Co.’s sprawling Dangjin Works complex, where a steady stream of 16-wheel trucks loaded with steel bar and coil head for the highway and the South Korean economy. Behind the walls, the massive, fiery blast furnace is pumping out enough steel to exceed last year’s 1-million-ton production.

Trouble is, the economy is slipping, steel prices are falling and the company has been bankrupt for years.

Hanbo is a massive vanity project that underscores a central South Korean problem: Despite all the pledges of reform, the nation still balks at closing assembly lines and shuttering factories in the face of rampant overcapacity, no matter how unprofitable or debt-laden they may be.

Such faux reforms have come into stark relief as the South Korean economy steadily weakens. In recent months, the local stock market has lost nearly half its value, inflation is on the rise and consumer confidence is down.

Furthermore, foreign investors are walking away, economic growth is declining, scandals have undercut economic leadership and currency markets are increasingly volatile. The price of semiconductors, which account for 14% of national exports by value, has fallen nearly by half since August.

Few believe South Korea is on the brink of another full-blown economic crisis. Growth for 2001 is still projected to be a robust 5%, but that is barely half earlier forecasts, and some expect more downgrades to come. The labor market is more flexible than it used to be, and several of the nation’s big industrial conglomerates have been restructured.

What the country is squandering, however, critics say, is the opportunity to transform its quick turnaround into a convincing, sustainable recovery.

And there’s more at stake than simple pocketbook issues. An economically vibrant South Korea is arguably far better positioned to negotiate with its erratic neighbor to the north, to extend foreign aid as needed and to finance projects that may have little or no payoff--an issue of grave concern for the security of northeast Asia.

That danger was underscored by the recent near-collapse of Hyundai Engineering & Construction Co., which has bankrolled most of the big industrial projects north of the Korean demilitarized zone and which now struggles with $7 billion in liabilities. It also calls into question the decision by President Kim Dae Jung to use a giant conglomerate as a tool of foreign policy.

Meanwhile, the deteriorating economy is weakening political support among voters for the Kim administration, whose initial reformist measures had become the basis for optimism among foreign governments and investors.

At a demonstration early this month in front of Seoul’s City Hall, several dozen Koreans in their 50s and 60s sit cross-legged on plastic tarps in the autumn chill, their shoes placed neatly beside them.

Cued by amplified chants from a portable microphone, they knock together rock-filled plastic bottles, protesting government moves to raise their rent and end the enormous subsidies doled out during the dictatorship of President Park Chung Hee.

“We’re really having trouble making ends meet,” says Ahn Sun Jo, a 60-year-old housewife wearing a protest banner. “We hoped this government would help the people.”

The public’s waning appetite for reform has emboldened opponents closely aligned with the old-line conglomerates, or chaebol, whose restructuring is perhaps the nation’s single most important reform.

In retrospect, it seems clear that South Korea bounced back too quickly from its 1997 brush with bankruptcy. This earned the nation praise from the international community for its flexibility, its ability to learn quickly and its readiness to implement reforms.

Unfortunately, the country started to believe the buzz and to act accordingly. Many tough prescriptions were watered down, wait-listed and then abandoned altogether. A sharp run-up in stock prices in 1999 and early 2000, which salvaged bank and corporate balance sheets, turned out to be fleeting.

Allegations of favoritism in government decisions returned as credit taps opened again for both the worthy and the unworthy, making a sham of economic rationalism. This month the IMF warned that “zombie” companies endanger a financial system already weighted down with $100 billion in nonperforming loans. Even as leaders continued to champion reform, relatively little was done.

“It’s called NATO--No Action, Talk Only,” says Kim Tae Dong, chairman of the presidential commission on policy planning. “We wasted two very valuable years during which the world economy was booming. And now we’re in a bad position.”

Still, some see reason for optimism. President Kim, whose overtures to North Korea recently won him the Nobel Peace Prize, knows that his place in history ultimately depends on achieving an equally dramatic shift on the economic front.

In particular, South Korea needs to end its decades-long bias toward protected markets, payoffs and government meddling ill suited to the 21st century. Supporters argue that Kim has the vision, the will and--with no election until December 2002--the opportunity to take some drastic measures.

The question is whether he can execute. Not only has his political support thinned, but also even staunch supporters concede that he’s put people with questionable credentials in several key economic posts. And the latest of many scandals to rock his administration--in which the nation’s Financial Supervisory Service watchdogs are accused of taking bribes to go easy on their charges--undercuts claims that tough economic steps will be fair, impartial and in the best interest of all South Koreans.

“Angry investors are now calling the FSS a Financial Robbery Service,” says Lee Hoon Pyung, a lawmaker with President Kim’s Millennium Democratic Party.

The president recently announced plans to “complete” economic restructuring by March, his administration’s third anniversary. And in a sign of progress to economists who believe more insolvent firms must be allowed to fail, Daewoo Motor Co. was allowed to slip into bankruptcy Nov. 8 and Hyundai Engineering is teetering on the brink.

But the March date is only the latest in a series of resolutions and deadlines announced and quietly dropped by the government over the years. Up to 25% of the nation’s companies are technically insolvent but continue to muddle along with the help of forgiving policies.

Nor is it clear that recent bankruptcies were allowed as a matter of principle or simply because the government has run out of money, options and suitors willing to absorb money-losing parts of the South Korean chaebol. Daewoo Group collapsed more than a year ago, yet its fate is still being debated, while Hyundai Engineering is on its fourth restructuring plan.

“They should’ve pulled the plug a long time ago,” says Kim Joongi, assistant professor at Yonsei University. “Once, maybe twice. But four times? I can’t understand why the government is so indecisive.”

The lack of momentum also has spooked foreign investors. Overseas portfolio managers, creatures with limited attention spans, have been fleeing South Korea in droves. Seoul’s composite Kospi stock index closed at 530.84 on Friday, a 48% decline for the year.

More important, foreign direct investors crucial to Kim’s stated reforms also seem to be losing interest. Global players bring not only much-needed capital to South Korea, they also force long-protected companies and workers to sharpen their skills or go bust.

In a series of recent high-profile rejections, Ford Motor Co. walked away from Daewoo Motor, Houston-based Nabors Industries Inc. jilted Hanbo Iron & Steel, and insurance giant American International Group Inc. appears to have lost interest in troubled Hyundai Securities Co.

The Hanbo story is emblematic of the economic dead weight South Korea needs to jettison. Groundbreaking for the huge Dangjin Works plant took place in 1991 even though the country already had several well-established steel makers.

In classic South Korean fashion, politics, not economics, determined access to capital. Founder Chung Tae Soo pursued his pipe dream in part by influencing lawmakers to influence state banks into granting massive loans. He was subsequently convicted on bribery charges.

No one knows exactly how much money was spent on this industrial wannabe, but estimates range from $4 billion to $7 billion. Senior Hanbo executives say even today they don’t have a good fix on the unit cost of the steel they produce under a traditional system in which only the top guy had the numbers--and a license to run a giant company like a personal fiefdom.

The timing couldn’t have been worse. Before construction was even finished, the financial house of cards collapsed, throwing Hanbo into bankruptcy in early 1997. Critics say Hanbo was the steel girder that broke South Korea’s back.

The failure battered its principal bank, Korea First Bank, in turn undermining confidence in the financial system. Hanbo’s debt now approaches 1,000% of its equity, compared with 30% to 50% for a well-run American company.

Three years later, about 80% of the sprawling Dangjin Works complex has never produced a single piece of steel as the company fights to keep up morale, creditors at bay and more steel pumping out of the towering blast furnace.

“Too bad it was never finished,” says Shin Seung Joo, a Hanbo manager. “Some have called it Sleeping Beauty.”

Nearby, giant concrete docks 100 feet tall stand like Easter Island figures at the sea’s edge. A lone worker scrapes rust from the docks on the off chance they will someday be dropped into the sea to greet arriving ships.

“We do our best to maintain the complex with limited funds, but it’s not easy,” says Choi Cheon Sik, Hanbo’s senior managing director. “Like a house, a factory is easier to maintain if you’re using it.”

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South Korea: Wrong Direction

South Korea’s rapid recovery from the 1997 Asian economic crisis has proved to be temporary as investors flee, growth slows, unemployment and inflation rise and consumers sulk. A look at key indicators for this year:

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A measure of inflation:

Kospi Stock Market Index: Nov. 24: 530.84

Consumer Price Index*: October: 2.8%

Unemployment Rate: October 4.1%

Consumer Expectation Index: October 89.88

* Annualized rate

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Sources: South Korea National Statistical Office, Bloomberg News, Hyundai Research Institute, South Korea Ministry of Labor