Chaebols are sweating but will they be allowed to fail?

By Yoke Har Lee

Among the leading industries in South Korea there is the perception that President Kim Dae-jung is so mighty he can "kill" the chaebols overnight.

In reality, the chaebols, or conglomerates, have rarely been allowed to fail in South Korea.

That is until now. Under the present Government the chaebols feel their influence vanishing.

Whether the chaebols like it, the heat is on them. But one question is whether big banks, creditors of the chaebols (the top five being Hyundai, Daewoo, Samsung, LG and SK Group) would be allowed to fail. Banks, most of them Government-controlled, have in the past provided financial guarantees to power Korean entrepreneurs, leading to the notion of the chaebols being "too big to fail".

To understand the grip of chaebols, one has to go back to the early 1960s when the country's entrepreneurs were instrumental in President Park Chung-hee's attempt to turn Korea from economic impoverishment to an industrial powerhouse.

Today, every facet of a Korean's life is dominated by a chaebol - from the cars driven on the road, the petrol they put in their cars, to the microwaves and special refrigerators they use to store their kimchi (pickled vegetables) at home. Every South Korean has a friend or a relative who works for a chaebol.

A job at a chaebol, the bigger the better, is considered a lifelong job, second only to the civil service, which still holds the distinction of providing a job for life.

Take Hyundai, the country's largest conglomerate. Hyundai makes the cars Koreans drive in. Its Oil Bank retail petrol kiosks fill the cars that power the Hyundai motors. Every morning, motorists probably drive across a bridge, one of over 10 bridges linking two parts of the city separated by the Han River, built by Hyundai Construction. The water supply is based on the country's dams built by Hyundai. At home, personal computers contain parts and memory made by Hyundai's electronics division.

At the peak of its fortunes in the early 1990s, Hyundai's total sales were about $US100 billion, more than New Zealand's gross domestic product. Hyundai has 57 companies under its wings, about 20 of them listed. By the end of 1999, 26 of these subsidiaries will remain, down from 79, according to Lee Young-kyu, who briefed the Business Herald on the company's plans.

Hyundai, which has absorbed the collapsed Kia Motors into its car-making division, hopes to slash it debt-to-equity ratio to 199 per cent according to the 1999 plan. After its asset reduction, the ratio should fall to 170.4 per cent, says Mr Lee.

Less clear is how the restructuring of Daewoo, the second largest chaebol, will pan out. Its affiliates' debt pile is nearly $US5 billion ($9 billion) and some analysts suspect the real figure could be larger.

To expedite Daewoo's slow progress, the Financial Supervisory Commission, headed by Lee Hun-jai, announced in mid-August that it planned to get Daewoo's creditor banks to sell off collaterals at their discretion.

Last week, the Government announced that Daewoo planned to trim its core units to six from 25 by year's end. Daewoo Securities, the company's cash cow will also be sold as part of its restructuring.

Chaebols will also be restrained from controlling non-banking financial institutions which have been a financing source for these conglomerates.

The country's top five chaebols own 39 financial institutions; 33 of them use their parents' names.

Chung Tae-seung, deputy secretary-general (planning) for the Federation of Korean Industries, said he believed that while foreign institutions doubted if chaebols were truly reformed, he was expecting chaebols to loosen their grip in the future.

He rated chaebol reforms as the highest priority, followed by the restructuring of financial institutions. And though progress is slow, the reform of the chaebols is way ahead of labour union and public sector reform.

He also predicted the chaebols would continue to change their corporate structures and, in a few years to come, would have improved their corporate governance.

While foreigners perceive the pace of chaebols' restructuring as glacial, the South Korean Government's intent to break up the power of the chaebols has drawn internal criticisms. Some fear harsh dealings of the chaebols might destroy Korea's industrial structure.

Research fellow at the state-funded Korean Development Institute, Dr Cho Dong Chul, feels that the size of the chaebols is not the root of the problem.

"Closer to the heart of the problem is the competition issue. After we have completed all of these reforms and if these enterprises still remained large because that is the natural outcome of the market, why should the Government not be happy about it?"

In the past, the chaebols fed themselves on distorted market practices and incentive systems. "The Government should fix these distortions not the size of the chaebols itself," Dr Cho said.

He said the most effective way for the Government to fix the chaebols' mess was to open up the financial sector and reduce state subsidies.

As yet there is no verdict on chaebols' failure. Whether it was because of their size, their inefficiencies or the strong nepotism in management, or their over-investment is still open to question.

There is no argument, however, that Government-backed guarantees for the chaebols have played a significant role in distorting the industrial landscape in South Korea.

Korea's banks were nationalised in the 1960s because control of banks was seen as crucial to push President Park's export drive.

The banks promoted investment in targeted industries fuelling the growth of the chaebols.

While there is no doubt the chaebols have been the driving force behind South Korea's economic boom in the late 1980s, the chaebol-Government relationship went to the extreme, breeding huge distortions.

The Korean Development Institute's researchers Yoo Seong Min and Lim Youngjae wrote in a February report that while the chaebols have lobbied for Government support to expand their empires, the Government and not the chaebols was responsible for the problems.

"The real danger here is that the past illegitimacy may justify today's irrational chaebol regulations, and the result is that the chaebols are paying for the Government's wrongs."

* This is the second of a series of articles on South Korea. Tomorrow: Looking at Korea's economy a year after Asia's financial meltdown.

* Yoke Har Lee went to South Korea at its Government's invitation.