ISSN 2330-717X

Chaebol Reforms Are Crucial For South Korea’s Future – Analysis

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By Sangin Park*

To understand the South Korean economy is to have an understanding of the chaebol, large business conglomerates controlled by their founding families. South Korea’s rapid economic growth since the 1960s — the miracle on the Han River — was driven by a government-led, chaebol-centred development strategy.

While the chaebols undeniably contributed to government-led economic development, they also caused a number of economic and social problems. The chaebols have been identified as a fundamental cause of South Korea’s 1997 economic crisis, and the deviant behaviour and economic crimes of their controlling families have been widely criticised. Yet, the chaebols continue to dominate the South Korean economy.

From 2009–17, intra-group trade occurred within 80 per cent of chaebol group firms, accounting for about 13 per cent of their total sales. Tunnelling through related-party transactions — which sees funds from a group firm with lower cash-flow rights transferred to a group firm with higher cash-flow rights to the benefit of family shareholders — has been rife.

The Monopoly Regulation and Fair Trade Act in 2014 introduced new regulations on related-party transactions within chaebols, but inadequate legal provisions have meant that such transactions are yet to be eradicated.

Economic concentration and industrial consolidation accelerated after the 1997 Asian financial crisis. In the Korean automobile industry, from 1998–2004, Hyundai Motors acquired Kia Motors while other major carmakers went into bankruptcy before being sold to foreign firms. This merger and reshuffle activity led to monopolisation in the automobile market and monopsony in the automobile parts and components market. Today, Hyundai Motors accounts for about 80 per cent of domestic automobile sales.

Once a monopsonist establishes exclusive supply chains with suppliers of parts and components, it begins to engage in price squeezing and intellectual property (IP) extortion when bargaining with its suppliers. Without punitive damages and rules of discovery in South Korean civil lawsuits, subcontractors know that they can be cut out of the monopsonist’s exclusive supply chain and left without viable alternative buyers.

Faced with profit squeezing and IP extortion, suppliers have less incentive for innovation. They become largely indistinguishable and replaceable, and even more vulnerable to price squeezing. This is how small and medium-sized enterprises (SMEs) lose both the incentive and the capacity to innovate and are forced to compete in terms of price alone, rather than in terms of quality-improvements or technological capacity.

But price squeezing is reaching its limit in low-end automobile models since new carmakers — especially those from China — have become viable in this segment of the market. The lethargic pace of innovation by South Korea’s car and parts producers has jeopardised its automobile industry as connected cars and electric vehicles gain traction.

In an economy concentrated in a small number of big business groups, monopsony and exclusive supply chains drive the widening wage gap between workers in SMEs and those in big chaebol firms. This discrepancy reflects price and profit squeezing by large monopsonists against small subcontractors in South Korea.

The decline in competition is common in other manufacturing industries, traditionally accounting for a large proportion of the country’s economy. The country’s export growth slowed from an annual rate of about 12 per cent over 2001–11 to 3 per cent over 2011–17.

The first chaebol regulations were introduced in the Monopoly Regulation and Fair Trade Act in 1986, but much like related-party transaction regulations, these had loopholes from the beginning. Chaebol reform recommended by the International Monetary Fund during the 1997 Asian financial crisis was ineffective in resolving economy-wide concentration by chaebols.

The Moon Jae-in administration has been slow to implement pledged chaebol reforms since taking office after the Candlelight Demonstrations in 2016–17. Worse still, the administration has pursued pro-chaebol policies even as Moon’s Minjoo Party racks up victories in local elections.

South Korea’s judiciary system is also notorious for its lenience toward chaebol founder families. The ‘three-five rule’ refers to a three-year prison sentence that is suspended for five years, regardless of the nature of the crime, and then exempted if no further violations occur during that period. Courts typically argue that the chaebol founder families are so valuable to the economy that it serves the public interest not to hold them accountable for their crimes.

Following Park Geun-hye’s impeachment in 2016, changes to the malpractice of the three-five rule were highly anticipated. But less than 18 months later, the Court of Appeals sentenced Lee Jae-yong, then vice chairman of Samsung Electronics, to two-and-a-half years in prison with a four-year probation for embezzlement and bribery of Park and her close confidant.

The concentration of economic power can be a threat to democracy and the market economy via judiciary capture. Since chaebols control a significant portion of a country’s economic resources, judges with career concerns are likely to make distorted judicial decisions that might benefit these families’ private interests.

Business groups with significant economic power can also influence the media, even when such groups are prohibited from holding news media assets in their portfolios. Following the Appeals Court decision in favour of Samsung’s Lee Jae-yong, some newspapers ran pieces supporting the court’s decision.

The interaction between political institutions and chaebols has had significant implications for South Korea’s economic growth since the 1960s. South Korea is now at a crossroads. Economic concentration is the root of the structural problems now faced by the economy and society.

The shift to an advanced industrial structure and innovative growth goes against the interests of the chaebols. An economic crisis may not be avoidable without fundamental changes in the country’s economic structure and policies. Chaebol reform is the key to these indispensable changes.

*About the author: Sangin Park is Professor of Economics at the Graduate School of Public Administration and Executive Director of the Research Center for Market and Government at Seoul National University.

Source: This article was published by East Asia Forum. An extended version of this article appears in the most recent edition of East Asia Forum Quarterly, ‘Asia after Biden’s election’, Vol. 13, No 1.

East Asia Forum

East Asia Forum

East Asia Forum is a platform for analysis and research on politics, economics, business, law, security, international relations and society relevant to public policy, centred on the Asia Pacific region. It consists of an online publication and a quarterly magazine, East Asia Forum Quarterly, which aim to provide clear and original analysis from the leading minds in the region and beyond.

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