South Korea and the Chaebol System: Part One

Today South Korea (or Republic of Korea, ROK for short) has a vibrant, diversified and highly dynamic economy but until very recently her economic system was dominated by a cartel of large conglomerates which had a disproportionate weight in economic policies and politics: these large conglomerates are called chaebol.
In Korean chaebol roughly means “clan owning property”. Some chaebol are household names throughout the world: Hyundai, Kumho, Hankook and Samsung. How did they come to become so incredibly powerful and why did so many of them fall without previous warning during the Asian Crisis of 1997, allowing Korea to become a freer, more diversified and stronger economy?

After the Japanese left the Korean peninsula, this was politically split in half, with the north entering the Soviet orbit (becoming the Democratic People’s Republic of Korea or DPRK) and the south entering the American orbit, becoming the ROK.
Between 1945 and 1948 ROK was governed by the US military (not unlike Japan) and during this period property previously belonging to the Japanese government, Japanese companies and Japanese individuals was confiscated and redistributed to Korean citizens and companies. The process was incredibly murky, with many allegations of irregularities but is sadly little documented outside of Korea to this day.

In 1948 the US military handed over power to the first elected president of ROK, the infamous Syngman Rhee. Rhee inherited a chaotic economic situation: the few industries expropriated from the Japanese were both starved for capitals and far between and the country was largely poor and agricultural. Rhee’s foremost ambition was unification of the Korean peninsula under his own rule. DPRK’s Kim Jong-Il harbored the same ambitions and tensions escalated into full-scale war in 1950. The ROK military, organized by the Americans as a militarized police and completely deprived of heavy armor, artillery and air support, was quickly routed by the well equipped DPRK army, necessitating a UN intervention. The war went on for three years, despite reaching an empasse in late 1951 already: the UN had the firepower and the better trained soldiers but the Soviet block was ready to take truly horrendous human casualties and had the advantage of internal communication lines. In 1953 the two sides agreed to the Panmunjom Ceasefire, which still holds to this day, no formal peace between ROK and DPRK having ever been officially signed.
In the aftermath of the war ROK was an impoverished country: infrastructures were in shambles, what little industry existed had been diverted to the war effort, hundreds of thousand had been killed and millions displaced. Rhee, however, had no clear plan of economic action. The US, still reeling from their costly mistake of not providing ROK with heavy weaponry, agreed to a hefty “aid package” which included weapons, foodstuff, fuel, industrial products and cash. Ironically most of these aids came from the newly reconstructed Japanese industry: during the Korean War the US had to grudginly allow Japan to quickly rebuild her economic strength to help fight the war. In short ROK quickly became heavily dependant on foreign aid which did little to improve overall economic conditions.
During the later years of the Rhee presidency, some of the families (or clans) which had obtained confiscated Japanese factories started to cultivate deep relationships with his administration: they received “special favors” in return for cash. In 1960, shortly after winning the election, Rhee was forced to resign due to a scandal and went into exile in the US.
An interim government was appointed, led by President Yun Bo-Seon and Prime Minister Chang Myon. Neither man was popular and to compel their difficulties the terrible state of the economy finally came into play as widespread riots and strikes started plaguing the country.
On May 16 1961 the military staged a successful and almost bloodless coup against the civilian government. After a few days of infighting, General Park Chung-Hee emerged as the leading figure among the golpistas. US President John Fitzgerald Kennedy immediately assured General Park of “total” US support and quickly recalled the US commander-in-chief in Korea, General Carter Magruder, who had urged ROK armed forces to “stay loyal” to President Yun Bo-Seon. Magruder never commanded anything larger than a desk again and was quickly sent into retirement.

General Park, a self proclaimed “staunch anti-Communist”, quickly announced to the nation his intentions of extirpating Rhee-era corruption and turn ROK into a modern, wealthy country. Japan, Korea’s neighbor and former master, was in those years experiencing a tumultuous economic revival and was obviously seen as an economic model of sorts by Park.
Initially the military junta jailed a number of prominent businessmen and factory owners on charges of being accomplices to the Rhee regime but charges were quietly dropped and the prisoners quickly released. Park had understood these men were the only allies he had in his ambitious plan of turning a backward, largely agricultural nation into an industrial powerhouse.
Working closely with the main industrial families, the Park government quickly came up with the following plan.
The private sector relinquished all financial activities to the State: all banks were nationalized. The various family-owned groups were reorganized along the lines of the old Japanese zaibatsu (and their modern day descendants, the keiretsu)*, becoming huge conglomerates with activities ranging from steel mills to breweries. In return for having relinquished all financial operations to the State, the families got in return precise guarantees they would get easy access to credit and their exports would be subsidized by keeping the won value pegged artifically low to the US dollar. Between 1962 and 1980 the won was officially devalued four times relative to the dollar, losing over 400% of its initial value.
Korea had 30 large family owned conglomerates at the height of the Park regime: these became known as the chaebol. Their economic growth was tumultuous. This growth was not fueled by their particular efficiency, but by cheap credit at home (which was mostly provided by the State-owned banks on a no questions asked basis by inflating the currency and restricting credit to the rest of the society) and massively subsidized exports abroad. Aside from an artificially devalued currency, the Park regime instituted crushing tariffs on many imported industrial goods and proved quite adept at negotiating excellent deals for the chaebol abroad. For example Park himself negotiated a peculiar deal with US President Lindon B. Johnson: in return for sending tens of thousand troops to Vietnam, ROK conglomerates got a monopoly on sundry supplies for Vietnamese troops and the US “pushed” for preferential tariffs on Korean goods in a number of South-East Asian States. Plus, additional funds were provided to the chaebol by foreign banks (for example to purchase capital goods and technology not available on the Korean market), with the ROK government guaranteeing the loans: the chaebol often had no interest in repaying the loans as the State-run banks would cover them in full and foreign banks weren’t wont on complaining or cutting credit lines as long as repayments were coming regardless of source.

While on paper it may seem like the chaebol system worked well to turn ROK into an economic powerhouse, it wasn’t bound to last. Already in the mid ’70s it started to show signs of deep strain. This long lasting crisis, whose effects are felt to this day, will be analyzed in the next installment

* the Japanese zaibatsu and keiretsu system will be covered in the near future. For the moment let’s just say this phrase, which is repeated everywhere from Internet sites to economic handbooks, has never convinced me. The Japanese conglomerates have two crucial differences with the chaebol. The first is that to this day at the heart of every keiretsu lays a huge, privately owned bank which acts as the main credit provider. The second is while all societies belonging to a chaebol are directly controlled by the owning family/clan, those belonging to a keiretsu are controlled in completely different fashion. But as I said the subject will be covered at a later date.

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