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Feb 28, 2017 | 09:15 GMT

12 mins read

Blood Runs Thicker in the South Korean Economy

The family-run conglomerates that made the country rich are at the center of its current political crisis.
(CHUNG SUNG-JUN/Getty Images)
Forecast Highlights
  • As South Korea's presidential election approaches, calls for the reform of the country's scandal-prone chaebols, or family-run conglomerates, will probably get louder.
  • As chaebols expand beyond their core industries, they are pushing out smaller businesses that provide much of the country's employment, adding another incentive for reform.
  • The economic pain that would come with meaningful chaebol reform will make it unlikely to occur without a constitutional amendment expanding the presidency beyond one term.

For better or worse, the story of modern South Korea is inseparable from that of the chaebols. Since their emergence under military strongman Park Chung Hee, who took power in 1961, South Korea's enormous, family-controlled conglomerates have formed the backbone of the country's export-dependent economy, driving and sustaining what came to be known as the "Miracle on the Han River." Today, the sales revenue of the five largest chaebols constitutes almost 60 percent of South Korea's gross domestic product, and their brands — Samsung, Hyundai and LG, among others — are household names. But perhaps even more important, the chaebols that dominate South Korea's political, economic and social life will also dictate the country's fortunes ahead.

Given their overwhelming importance to South Korea, chaebols have long been targets of criticism at home and abroad, and the calls for their reform are nearly as old as the conglomerates themselves. Since South Korea's transition to democracy in the early 1990s — and especially in the wake of the Asian financial crisis in 1997 — chaebols have been subject to the tides of electoral politics. Detractors demand that chaebols increase their transparency and improve their corporate governance, making them less prone to corruption, as well as check their monopolistic tendencies or even break apart. But although nearly every South Korean president since Kim Young Sam, who took office in 1993, has promised to rein in the chaebols, they are still as influential today as they have ever been.

South Korea's Chaebols dominate the country's economy, as shown in this neat chart

Many factors explain their enduring power. In part, the chaebols' clout grew as the global economy shifted after World War II, driving South Korea's emergence as an export and industrial powerhouse. The conglomerates were poised to meet growing demand for new suppliers of capital-intensive heavy industrial goods (and later, electronics). But more directly, their influence is the product of a concerted push by the government in Seoul to transform the country from a poor, war-torn agricultural society into a manufacturing giant in the span of a few decades. As key instruments of the transformation, chaebols benefited from unparalleled access to and support from the state.

The tight links between Seoul and the chaebols helps explain why the conglomerates have been so resistant to reform and why successive presidents have proved either unable to or uninterested in eroding their privileged positions. For although the relative fortunes of various chaebols have fluctuated with the changing of parties and administrations, the basic structure that unites the interests of South Korea's political leaders and the chaebols has been left largely unchanged.

An Opening for Reform?

Amid the political upheaval that followed recent revelations of corruption and influence peddling in the administration of President Park Geun Hye, calls for chaebol reform are once again reaching a fever pitch. In December 2016, the South Korean parliament questioned the heads of nine chaebols — Samsung, Hyundai, LG, Lotte, SK Group, Hanwha Group, Kanjin, Korean Air and CJ — over allegations that the firms had funneled some $70 million to nonprofit foundations controlled by Park's aide and confidante, Choi Soon Sil. Most notably, Samsung heir apparent Lee Jae Yong was arrested over $35 million in gifts his company made to Choi's foundations. Prosecutors say the money was offered in exchange for government approval of a controversial merger between two Samsung affiliates, which helped Lee Kun Hee secure his control over the conglomerate, in an attempt to evade the country's stiff inheritance taxes.

The political scandal surrounding Park and her ties to powerful chaebol leaders likely ensures that chaebol reform will take center stage during the campaign for the presidential election that South Korea will hold sometime this year. But although the affair has stirred public anger at the conglomerates, creating an opportunity for more substantive chaebol reform, no concrete proposals have been made about what form it will take or how far it will go.

The Barriers to Regulating Chaebols

The South Korean government's struggle to regulate the chaebols dates back to the Monopoly Regulation and Fair Trade Act of 1980, which created the country's leading antitrust watchdog, the Korea Fair Trade Commission. The law came, in part, as a response to growing fears that as chaebols gained control over businesses outside their initial core industries, they would squeeze out the country's small and medium-sized enterprises, the backbone of employment nationwide. But though the law laid the foundation for the chaebols' regulation, it did little to restrain their expansion. Throughout the 1980s, chaebols continued to grow in size and importance, not least because of their crucial role in driving South Korea's economic success. 

Despite persistent government efforts to tighten controls on the family-run conglomerates, there was little Seoul could do to constrain them without slowing the economy.

The combination of insufficient oversight and minimal transparency — institutional investors and other minority shareholders without family connections often lacked any real influence in chaebol decision-making — set the stage for economic problems to arise. By the mid-1990s, easy access to financing had led to spiraling overinvestment by chaebols, sending their debt-to-equity ratios skyrocketing. In early 1997, the top 30 chaebols averaged debt-to-equity ratios of 500 percent, well over double the average among members of the Organization for Economic Cooperation and Development. The top five chaebols alone accounted for nearly 30 percent of South Korea's total corporate debt. Unsurprisingly, during the Asian financial crisis that year, the collapse of South Korea's currency, the won, gave way to a liquidity crunch as small and medium-sized enterprises crumbled and chaebols struggled to service their mounting debts.

The crisis — and the International Monetary Fund agreement that followed — ushered in a second wave of chaebol reform and restructuring efforts. In 1999, Daewoo, then the second-largest chaebol, filed for bankruptcy holding $78 billion in outstanding debt — $20 billion more than the IMF’s 1998 bailout package for the entire South Korean economy. Meanwhile, the family of Hyundai founder Chung Ju Yung was forced to transfer control of most day-to-day operations at the company (then Korea's largest conglomerate) to international investors and professional managers. Other chaebols had to undergo corporate restructuring, either collapsing or shedding subsidiaries (often numbering in the dozens) while the South Korean government tightened financial controls by prohibiting debt guarantees among affiliated businesses within the same conglomerate.

Those reforms helped lower chaebol debt levels and improve transparency and productivity within the conglomerates. But enduring economic volatility in the early 2000s, combined with President Kim Dae Jung's need to maintain economic stability as it engaged with North Korea, blunted the effect of the reforms. As Kim's term wound down in 2002, momentum for chaebol restructuring ebbed. With the economy still recovering, neither Kim's party nor the opposition had much interest in continuing reforms that might provoke backlash from leading chaebols. The same pressures similarly constrained Kim's successors. Though the heads of several prominent chaebols were convicted of corruption, bribery and tax evasion over the next decade — including Samsung's Lee Kun Hee (pardoned by President Lee Myung Bak) and SK Group's Chey Tae Won (pardoned by Park Geun Hye) — the country's policies continued to favor the conglomerates' growth and dominance. This prominence was only reinforced by the global financial crisis in 2008.

Buttressed by rising demand from China and a steady recovery in U.S. consumption, South Korean exports rose by 57 percent from 2009 to 2014, peaking at $573 billion in 2014 (about 40 percent of the country's GDP). Though it is difficult to say with precision what portion of those exports came from chaebols and their affiliates, South Korea's top 10 exports — which accounted for almost 88 percent of total exports in 2014 — were from industries traditionally led by the conglomerates. Popular opinion of chaebols, which had been negative for much of the past 15 years, softened somewhat as they outperformed many of their global competitors. Meanwhile, the characteristics that had earned chaebols criticism in the past — family control and opaque corporate governance — were increasingly credited with enabling the conglomerates to think and act strategically rather than react to changing circumstances.

The Specter of Change

By 2014, the economic slowdown in China, along with sluggish growth in the United States and Europe, began to take a toll on South Korea's economy. Over the past two years, the value of South Korean exports has fallen by nearly 30 percent. Though unemployment as a whole remains low, unemployment among youths — a sizable portion of the South Korean workforce — is climbing, and seasonal unemployment spikes are becoming sharper. In February 2016, youth unemployment reached 12.5 percent, more than triple the national average. Slower growth has compounded public frustration over scandals involving family members of leading chaebols, culminating in the political crisis that followed revelations of collusion and bribery between the chaebols and the Park administration. 

In the furor following Park's political demise and as national elections approach, virtually every presidential candidate has made chaebol reform a centerpiece of their campaign.

Opposition leader and presidential frontrunner Moon Jae In has promised to create a special agency to investigate chaebol business practices and punish wrongdoings. Then, on Feb. 13, Yoo Seong Min — a potential candidate from the Bareun Party, a splinter of the ruling Saenuri Party — stressed the need to support small and medium-sized businesses, self-owned firms and startups by ensuring that chaebols engage in fair competition. More calls for chaebol reform are sure to follow as the campaign season heats up. Proposals could include adjusting the country's inheritance tax rates, which are the second-highest in the world, to reduce the pressure that heirs to family-owned firms feel to borrow from the conglomerates' subsidiaries to pay them. Other changes could focus on dialing back chaebols' expansion.

The extent to which any reforms are actually carried out will depend both on who wins the presidency and how the political crisis surrounding Park unfolds. If Park escapes the kind of punishment that many Koreans expect her to receive, demands for thorough chaebol restructuring and much stronger oversight will likely mount. Likewise, continued economic weakness could lend momentum to chaebol reform by fueling public anger over rising income inequality. Alternately, a deeper economic slowdown or stagnation could raise concerns over any measures that threaten business continuity at "too-big-to-fail" companies such as Samsung or Hyundai.

This last fear perhaps best explains why, despite decades of piecemeal chaebol reform, the conglomerates remain as powerful as ever. Though the chaebols account for a relatively small share of South Korea's total employment (under 3 percent in 2010), their influence touches nearly every corner of the economy. In recent years, that influence has grown as the chaebols have maintained control over their core industries — electronics, heavy industry and shipbuilding, for example — while expanding into service industries such as shopping malls, movie theaters, grocery stores, and even burger joints and coffee shops, easily displacing smaller businesses. This expansion puts South Korean lawmakers in a difficult position. On one hand, as the chaebols become bigger and more pervasive, the likely impact and risks of restructuring them grow. But on the other, their intrusion into nontraditional industries also stokes public anger, raising the political consequences of inaction.

Precedent suggests that it will take more than a political crisis — even one as significant as the scandal engulfing Park — to bring about meaningful chaebol reform, such as changes in corporate governance structure that would curb family control and address the roots of chaebol corruption that is driven in part by laws like the inheritance tax. More likely, a fundamental overhaul of the chaebol system would require an economic crisis profound enough to delegitimize the system of political-economic organization embodied by the chaebols, a model that is wearing thin but is nonetheless still intact.

Constitutional Revision as a Path to Reform?

Though South Korea's current political crisis may not be enough to inspire substantive chaebol reform, it could pave the way for another change with important long-term implications for the conglomerates: a constitutional revision to allow presidents to serve two terms. The country's existing single-term, five-year presidential system was intended to prevent another strongman-led government from overstaying its time in office. But over the past two decades, the limits of the single-term presidency — which simultaneously constrains executive accountability and all but guarantees that each administration becomes a lame duck in its final year or two in office — have become clear, prompting calls for change. As of 2016, 80 percent of South Korean lawmakers and most voters supported instituting a two-term presidency.

The consequences of a one-term presidency are particularly serious when it comes to popular but politically risky issues such as chaebol reform. An effective reform program would likely take many years, requiring sustained public support and a willingness to absorb the short-term costs that would follow any move to dismantle the chaebols' control over key sectors of the economy. This would be difficult to achieve in five years, even for a committed president. A two-term presidency, however, could offer leaders the ability to embark on longer-term reforms in the face of immediate political and economic blowback.

But even a president equipped with a popular mandate and two terms in office would face a steep uphill battle in implementing reforms that threaten core elements of the chaebol system. Features such as family control are central to the conglomerates' operations and arguably to their capacity to compete on a global scale, especially during periods of economic volatility. Beyond the chaebols' own efforts to lobby Seoul against reform, these features explain why, without the impetus of a severe economic crisis, major chaebol reform is unlikely.

For now, it is unclear when or how such a crisis would unfold. But what is clear is that when a crisis deep enough to undo the foundations of South Korea's modern economy emerges, its impact will likely reach well beyond the chaebols, touching every aspect of social and political life in the country. To the extent that the chaebols help to define modern South Korea, however, a post-chaebol era would mean a new stage in its history.

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