Why Seoul Is Seething

Koreans want the mismanaged chaebol to share the economic pain

They looked so out of place, with their conservative suits and smart haircuts. But there they were, masses of Seoul's bank clerks and middle managers, braving freezing temperatures to march alongside hardened Korean factory hands and voice their outrage at a new labor law. The squadrons of riot police, packed in serried ranks behind menacing shields, made no exceptions for these white-collar protesters. They lobbed the same tear gas at clerks and managers that they have used against the workers who have been marching by the hundreds of thousands in Seoul since late December.

Ritual clashes between police and workers are nothing new in Korea. But the appearance on the scene of middle-class protesters clearly shows something new is afoot in this country. There's a new anger to the protests, anger at a just passed law that makes layoffs possible, a law many Koreans see as a sign of a return to the bad old authoritarian days. But besides anger, there's fear as well. The protesters sense that Korea's economy and society are changing so rapidly that soon many cherished parts of life--including lifetime employment and steadily rising wages--will be a thing of the past. The anger and fear are so intense they have sparked strikes at dozens of plants and cost the economy billions in lost production.

MIRACLE TO MALAISE. Behind the turmoil is a profound crisis in Korea's political and corporate elite that highlights the strategic missteps of Seoul's policymakers and the giant corporations known as the chaebol. South Korea became one of the dragons of Asia through a heavily regulated, export-driven model that also insulated the chaebol from serious competition in their domestic market. Workers had few rights and had to endure tough conditions, but they were rewarded with lifetime jobs and good raises.

Now that mercantilist model is turning the Korean Miracle into the Korean Malaise. Costs are threatening the competitiveness of the chaebol--which are borrowing massively to conquer overseas markets. Yet margins are low in businesses as diverse as autos and semiconductors. And Korea's Asian brethren in Singapore and Malaysia are muscling into the same turf. Meanwhile, the chaebol can no longer afford to pay the price of social peace--high wages at home.

The government's latest effort was a badly fumbled attempt to provide relief to Korean businesses by driving down labor costs. The law was rammed through parliament by President Kim Young Sam's party on Dec. 26, without opposition members present. The legislation makes it easier to fire employees and hire part-time workers, yet it keeps new unions illegal until 2000. Since the bill was passed in the semisecret, predawn parliamentary session, strikes have spread nationwide as workers for the major chaebol have reacted with fury to this violation of the social contract.

Even before the protests paralyzed so many factories, problems were piling up in Korea. The Korean stock market has been in a free fall, plummeting 26% last year. What's more, the weak Japanese yen and cyclical price declines have combined to slash prices on Korea's key export products--notably memory chips, steel, and petrochemicals. Earnings have plunged, and export growth has slowed, rocketing the current-account deficit to $23 billion last year, or a lofty 4.7% of gross domestic product. "We have to build a new economic model," Deputy Prime Minister and Finance Minister Han Seung Soo told BUSINESS WEEK. Korea's growth, which slowed to 6.8% in 1996 from a torrid 9.0% in 1995, may slide to 6.2% this year.

The sense of crisis and economic mismanagement has aggravated the anger of the unions. With Korean unemployment benefits only in their infancy, workers feel they are being made to bear all the pain while the chaebol get more competitive. "We're at the initial stage of a new dictatorship under which the chaebol control the civilian government," says Choi Dong Young, a 36-year-old laid-off auto worker and union organizer outside Myongdong Cathedral in Seoul.

The workers' rage is partly justified, but it doesn't change the fact that costs are out of control in Korea. Real wages rose an annual average of 8.2% in the decade through 1995, far outstripping productivity gains, which averaged 6.5% (charts, page 23). Compounding the problem are logistic nightmares that drive up costs. Roads are continually congested, and ships arriving at Pusan port have to wait days to dock.

While the chaebol want to chop costs at home, they are also massively shifting investment outside the country. The top four chaebol--Hyundai, Samsung, LG, and Daewoo--have been investing billions in the U.S., Europe, Asia, and the old Soviet bloc. Little wonder. Even advanced countries such as Britain offer manufacturing wages up to 30% lower than Korea. The average consumer-electronics factory worker makes $6.94 an hour in Britain, compared with $9.99 in Korea. In a now typical move, LG announced in July that it was building a $2.8 billion plant in Wales.

"PROFITLESS PROSPERITY." Shifting assets abroad will not solve all the chaebol's self-created problems. The family-owned and -managed groups are famous for their autos, electronics, and other capital-intensive businesses. Yet they have diversified into unrelated fields as far-flung as fertilizer and restaurants, undermining their ability to compete in key industries. Chaebol profits remain dangerously dependent on products subject to volatile pricing trends.

With the government arranging easy access to capital, the chaebol have piled into export-oriented, capital-intensive industries such as cars and semiconductors. One result has been a "profitless prosperity" of overcapacity, declining profit margins, and growing dependence on developing markets. "The question is, will we go bankrupt or find a solution?" says Lee Keunmo, research director at ING Barings Ltd.

Previous attempts by President Kim to use tax cuts and other incentives to force the sprawling chaebol to concentrate on core products have been to little avail. The chaebol have only gotten bigger. Sales by the top four conglomerates account for about 80% of Korea's GDP and half of total exports. Affiliated companies of the top 30 chaebol grew from 623 in 1995 to 669 in 1996. And family ties among chaebol owners are spawning new chaebol. One chaebol, for instance, is run by the sister of Samsung Group head Lee Kun Hee, while another is controlled by the brother of Hyundai Group founder Chung Ju Yung.

The latest hope of curbing chaebol power was dashed in October, when the New Korea Party blocked attempts to require consolidated financial statements. These would have made the intricate network of cross-subsidies among chaebol affiliates more transparent.

Some chaebol are trying to slam the brakes on runaway expansion. Samsung Group was hit badly when prices for 16-megabit dynamic random-access memory chips (DRAMs) collapsed from $80 at the end of 1995 to about $10 now--just about the break-even point. The decline contributed to a 5% fall in the group's exports last year, to $21.4 billion. Now, says Jee Seung Lim, Samsung's senior managing director for strategic planning, the company plans to halt production of 29 products, such as construction equipment, and stick with things like semiconductors. "We will concentrate on a few selected products in which we can enjoy monopolistic market share," he says.

Many of Korea's problems in its business sector are similar to Japan's. But unlike its neighbor and industrial mentor, South Korea lacks Japan's huge domestic market and technological strengths. Instead of being cash-rich, Korean corporations are highly indebted, with an average debt-to-equity ratio in excess of 200%. "Without massive restructuring, Korea will be the most vulnerable Asian economy to the global deflationary trend of the 1990s," says Rhee Namuh, director of research at Dongbang Peregrine Securities Ltd.

The Korean government has taken a few steps to address the problems. In addition to the labor law, Kim Young Sam used his annual New Year's address to announce the formation of an advisory committee on financial reform. But with a presidential election scheduled for December, the prospects for significant reform this year are slim. Economists fear political concerns will have the government reverting to old, preelection tricks, intervening in the stock market and knocking down interest rates. These moves would stoke inflation, projected at 4.8% this year. "Political considerations will make things worse. Then we'll need a bigger adjustment in the future," says Kang Ho Sang, professor of international business at Sogang University in Seoul.

Ominous cracks in the financial system have been evident for years. Throughout Korea's rapid development stage, government used banks to channel scarce capital to the chaebol. Yet many loans have gone sour, particularly those related to the misguided attempt to create heavy and chemical industries in the late 1970s and early 1980s. Analysts reckon nonperforming loans add up to some $24 billion, about equal to the banks' combined equity capital.

Cleaning up Korea's banking system is an enormous task, but one that's necessary if the sector is to compete internationally. Korea is overbanked, with 25 domestic commercial banks, about 3,000 small mutual-savings banks, and 20 major securities companies. That's about one financial institution for every 6,000 people--five times above the Organization for Economic Cooperation & Development average. In the next few years, analysts expect a few commercial bank megamergers. The small mutual-savings banks are also likely to collapse into several hundred. Securities firms have already begun to align themselves with foreign partners to gain global reach.

"DRASTIC REFORM." Only full financial deregulation will root out red tape and cronyism and instill a new competitive attitude. Here again, the political challenge is daunting, since the instinct to intervene runs deep among government mandarins. As in Japan, Korea's Finance Ministry is a powerful institution staffed by career employees loath to surrender their power to market forces. "We need drastic reform, but lower-level officials want to monopolize the process," says Finance Minister Han.

Insiders warn that Korean bureaucrats are unprepared for truly liberalized markets. Not only are the rank and file resistant to change, few have the expertise to monitor sophisticated financial markets and instruments. A survey by Chosun Ilbo, Korea's leading daily, found that 80% of 119 foreign executives cited lower-level bureaucrats as the biggest barrier to doing business in Korea. "As long as the red tape remains, corruption will persist," says the manager of a small venture-capital firm. "The kickbacks that some bureaucrats demand have only gone up."

WHY SEOUL IS SEETHING (int'l edition)

Over the past few decades, Korea's economic development has been a miracle and a model for others. Yet growth will grind inexorably lower unless the formula is fundamentally changed. President Kim, and whoever succeeds him, will have to form a national consensus if Koreans are to go forward together. "We are ready to buckle down and work harder, but management must also face reality," says Kim Doo Ran, an electrical-parts worker in the port city of Inchon. The strikers have shown that authoritarian moves are the wrong way to overhaul the economic system. Now, all Korea must accept the opportunities and challenges of free markets and free politics.

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