Such bailouts are a disquieting reminder that ties between the South Korean government and the debt-splurging chaebols remain unnaturally close and that President Kim Dae Jung has reneged on a restructuring program that once had a slogan "No company is too big to fail." If the government continues along the rescue path, it risks undermining not only South Korea's economy but relations with some of its closest trading partners.
It was government intervention in the economy and massive infusions of credit to the chaebols that exacerbated the 1997 financial crisis. The disaster prompted the G-7 nations to orchestrate an unprecedented $58 billion bailout for the South Korean economy, including a $21 billion loan package from the IMF. In return, South Korea agreed to not intervene in bank management and lending decisions, to eliminate subsidies and tax privileges to individual corporations, and to allow bankruptcy laws to operate unfettered.
Initially, these reforms began to fundamentally change the chaebols. The mutual debt guarantees among group firms that allowed them leveraging were banned. So were the cross-shareholdings and intra-group transactions that held their web-like structures together. The groups were ordered to appoint outside directors to their boards, adopt international accounting practices and replace family CEOs with professional managers.
The three-year stand-by arrangement with the IMF expired Dec. 3, 2000. During that period, according to the IMF, South Korea made significant progress stabilizing its financial system, improving corporate governance, increasing transparency, liberalizing capital markets, and forcing businesses to observe market discipline. Indeed, the nation's gross domestic product grew 10.7% in 1999 and 9.5% in 2000, with unemployment declining to 4% in 2000.
Despite the progress, domestic and foreign confidence in the economy is falling. While this is due, in part, to the downturn of the global economy, blame also lies with the fact that the chaebols are fighting back, if not actually getting bigger. According to a recent report by South Korea's Fair Trade Commission, the top 30 business groups added a net 18 companies in April to bring their total to 642, or more than 20 companies per group.
With jockeying for South Korea's December 2002 presidential election campaign already under way, the conglomerates - by far the biggest source of campaign funding - are flexing their muscles over the extent of reforms. A petition recently sent by the Federation of Korean Industries, a group representing the chaebols, to the government demanded it relax IMF guidance requiring the 30 largest groups limit the debt levels of their companies to 200% of their net assets. The petition also asked for the delay of a ruling that requires chaebol companies to reduce their holdings in affiliates to 25% of their total assets.
These regulations were aimed to prevent debts from piling up in a fragile banking system and to deter the chaebol expansionism that led to excess manufacturing capacity. But the chaebols complain the restrictions violate free-market principles and limit investment in new sectors. The Fair Trade Commission report notes most of the new chaebol units have cropped up in the new economy - mobile phone services, health care and Internet-related businesses. The government has agreed to review the regulations.
The starkest example yet of government subsidies to ailing industries was last week's decision to transfer $4.3 billion of public funds to the state-run Seoul Guarantee Insurance Co. to save Hynix and other former affiliates of Hyundai and Daewoo. Hynix's rescue package allows 17 creditor banks to buy one trillion won in convertible bonds from the company, as well as provide debt extensions and credit lines equal to four trillion won. Korean asset-management companies will purchase new bonds totaling 680 billion won on the condition they be guaranteed by SGI.
The U.S. Trade Representative, already concerned that much of the South Korean government's lending to support restructuring efforts has gone to export industries, may take the Hynix case to the World Trade Organization, where the European Union is threatening to lodge a complaint over a related case. An investigation by the European Commission alleges the South Korean government granted substantial subsidies, mainly through export schemes by the state-owned Korean Export-Import Bank, to cash-strapped shipyards, including Daewoo Shipbuilding & Marine Engineering Co. and Samho Heavy Co., during the 1997-98 financial crisis.
Although the beneficiaries of the South Korean government's largesse suffer from their own poor business decisions, many troubled firms would be attractive to foreign or domestic investors if they were offered for sale. Hynix, formerly Hyundai Electronics Industries, for example, was responsible for approximately 5% of South Korea's total exports in the late 1990s.
Why hasn't the South Korean government learned the lessons of the recent past? Undoubtedly, politics, including support for the "Sunshine Policy" and its offer of investment to North Korea, have influenced the government's decision to shield vulnerable chaebols from bankruptcy, as have fears of widespread labor unrest.
But bankruptcy isn't politically impossible and doesn't mean chaebol affiliates must close their doors or stop production. It simply means creditors will lose some of their money. The size of the hit creditors take, however, will only increase under a bailout policy.
The government's tendency to prop up the economy both lowers the incentives for chaebols to put their economic houses in order and raises the costs of doing business. It also increases the risk of an economic meltdown like the one that occurred in 1997. According to a recent estimate, 58% of South Korean companies are junk-rated, totalling 63% of corporate debt.
In the short term, rescues may relieve the government of its immediate domestic political pressures. But they are the kind of practices foreign investors are already questioning as dangerously "back to the future."
Brett D. Schaeferis Jay Kingham fellow in international regulatory affairs in the Center for International Trade and Economics at The Heritage Foundation.
Originally appear in the Asian Wall Street Journal (05/20/01)