Sun, Aug 27, 2000 page9

• S Korea's choice: growth or dump the holy chaebol

  • By Christopher Lingle
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  South Korea's industrial conglomerates, known as chaebol, were once seen as a driving force behind that country's previous high rates of economic growth. At the beginning of the country's financial crisis, optimists saw them as the engine that would pull South Korea out of its doldrums.

  Indeed, there are about 40 chaebol that still account for about 80 percent of GDP and 50 percent of exports despite most of them facing difficult financial straits.

  It is ironic that leaders in Beijing once considered the "Korean model" as a means to resolve China's restructuring problems. However, the chaebol are an outcome of the institutional arrangements that led to the South Korea's economic crisis. As such, they are the problem, not the solution. They are part of the past, not the future.

  Government involvement in directing economic development encouraged the concentration of industrial production. Favored treatment from the government in the past caused the chaebol to over-expand, including into areas where they had no experience or comparative advantage. In particular, encouragement for the establishment and support of the chaebol led to increased inefficiency through the cartelization of the domestic economy.

  In turn, these conglomerates began destroying shareholder value with impunity while setting their sights on market share and expansion instead of profits. South Korea's crisis arose from problems for which there are no simple economic solutions. Decades of interventionist policy have thoroughly corrupted the political system and stimulated a high degree of political cynicism and contempt for political processes.

  Political order and economic recovery require that the chaebol be stripped of all their privileges. Only then can the economy become free with truly sound fiscal and monetary policies.

  South Korea, the world's ninth largest economy, recorded 13 percent growth the fourth quarter of 1999 and became the poster boy for successful rebound from crisis. But its economy is not out of the woods; not by a long shot.

  Sure, exports are booming. But then there are continuing concerns about the domestic sector, which is the largest component of the economy.

  After an impressive and encouraging run-up, share markets are now down by about 30 percent for the current year, including a recent drop of precipitous proportions. And the culprit? Once again, the blame is laid at the feet of the chaebol. In this instance, it is the Hyundai Group.

  When domestic banks were brought to their knees by the chaebol's bad debts, depositors moved their assets into investment-trust companies (ITCs).

  These were then tapped by the capital-destroying chaebol, doubtless because of their extensive cross-shareholdings with the ITCs. Once again the entire financial system has been put at risk because the commercial banks are holding much of the debt of the investment trusts.

  Daewoo's collapse was a significant factor in the 5 trillion won in losses recorded by South Korea's banks in 1999. Daewoo had been the second-largest chaebol and collapsed under its debts of US$78 billion debt, an amount US$20 billion more than the IMFs 1998 bailout package for entire country.

  An asset management fund, the Korea Asset Management Corporation (Kamco), has purchased bad debts with face values of about 75 trillion won (US$66 billion). It has recouped about 14 trillion won through re-selling them on to domestic and foreign buyers.

  There are some signs that government intervention in the banking system to prop up failing companies will eventually stop given the announcement that it will no longer fully guarantee deposits.

  It remains to be seen whether enough political will can be mustered to endure continuing debt write-offs and liquidations of insolvent firms that will unavoidably lead to rising unemployment. But it is all necessary before there can be a net inflow of capital that is needed to assist with recapitalization of the banking system.

  Although the list for what steps need to be taken is now well-rehearsed, it bears repeating. It is important that domestic-currency bond market emerges so that local companies will not be so dependent on foreign-currency bond markets. Many of the problems associated with the 1997 crisis arose from companies being unable to meet debt payments as the won's devaluation.

  Increased transparency and accountability will arise through limiting the cross-subsidization of lending within chaebol groups and by ending the heavy reliance upon bank lending. When corporate lenders are forced to turn to domestic capital markets, they will encounter lenders that are constantly reassessing credit worthiness of each borrower.

  Recent steps have boosted the country's underdeveloped domestic bond market. Securities companies will be allowed to specialize in bond trading while bond-sale procedures will be simplified and standardized.

  Korean securities will become more attractive when local companies improve their disclosure process.

  There should not be too much emphasis on the restoration of South Korea's export s, because the overall economy will continue to lag until the domestic sector develops a basis for sustained growth.

  This will require more investment funds going to small and medium-sized enterprises and that will occur only when the chaebol have truly cut excess capacity and have stopped absorbing the lion's share of capital lending.

  Christopher Lingle is Global Strategist for eConoLytics.com and author of The Rise and Decline of the Asian Century. His E-mail address is: CLINGLE@eConoLytics.com.
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