South Korea and the Chaebol System: Part Two

For Part One:

The ’70s marked a turning point in the chaebol system, and not for the better. The general worldwide slump which followed the abolition of the Bretton Woods Treaty (1971) and the First Oil Crisis (1973) had a very noticeable effect on Korean exports. However there were a number of other issues which rattled the chaebol system. As a first thing, the chaebol had traditionally been very dependent on low value-added goods like textiles, footwear, low-grade steel and simple chemicals. These goods were mostly exported to South-East Asian nations like Thailand, The Philippines and Indonesia. However as the ’70s progressed these nations, especially Thailand, started to be able not only manufacture the same goods locally, but also to export them, and at prices competitive with heavily subsidized Korean goods.

Worse still, the chaebol found a formidable foe in the Japanese keiretsu. Japan’s tumultuous growth bears little relationship with Korea’s. It wasn’t fed by cheap credit and an artificially devalued currency but by massive capital accumulation and an almost staggering rate of investments. This meant the keiretsu were incredibly efficient on foreign markets, and not only in exporting cheap, low value-added goods. In 1968 Toyota started selling her first highly successful car in the US, the Corona MkII. The same year also saw the first Japanese cars (Daihatsu) arrive in Europe and Honda started selling her first large displacement motorcycle both at home and on export markets. The ’70s saw the Japanese keiretsu becoming prime movers at world level in high value-added goods: electronics, industrial machinery, complex chemicals etc. The situation became so desperate the chaebol implored the Park regime to help them become more competitive in the high value-added goods sector. This was achieved by the usual means: massive financing by the State-owned banks and further rounds of devaluation to make Korean goods (in the period generally seen as much lower quality than their Japanese counterparts) more palatable to foreign buyers. As one Korean economist said “It was a very painful process for the nation as a whole”. To provide more credit to the chaebol, the rest of the country was both denied credit and heavily taxed through massive inflation. This especially afflicted areas outside the industrial districts: standards of living in rural areas were very low and farmers’ productivity was still at ’50s levels, large scale mechanization having been made impossible by both lack of credit and low saving rates.

In the late ’70s General Park was becoming increasingly unpopular due to both this long economic crisis and his autocratic rule and in 1979 he was assassinated by a group of KCIA* officials. The assassins were quickly arrested by the army, brutally tortured and executed without trial. To this day it’s still hotly debated if Park’s assassination was part of a failed coup or personally motivated. Power passed on (after a brief civilian government) to another military strongman, Major General (later Lieutenant General) Chun Doo-Hwan, which ruled as a dictator from 1979 to 1980, and then as elected president from 1980 to 1988.

President Chun inherited a terrible situation. The economic disparity between rural areas and the industrialized districts (chiefly the Gyeonggi Province, centered on Seul) was staggering. Coupled with the repressive nature of the military regime this led to a number of rebellions which were put down with extreme brutality. It later transpired the ROK military, despite its hatred for the DPRK and China, had copied the “reeducation camp” system from its northern neighbors. However this was nothing compared to the worries about the State-run banking system. Bad loans had piled up for two decades, accelerating during the late ’70s, and, coupled with the need to finance the grandiose public works projects so dear to General Park and repaying the chaebol‘s foreign loans, had left the banking system very fragile. In 1983 a complete collapse was averted thanks to an emergency loan by Japan, whose terms are unknown to me. The Chun Administration hence started to enact drastic reforms to avoid the whole country falling down like a house of cards. As a first thing, slowly but steadily, the banking system was privatized. This was a very drawn-out process which took years to complete and whose effects are felt to this day, as Korean banks are not as efficient and competitive as one would imagine them to be. As a second thing the rate of money creation was drastically cut, allowing inflation to be kept under control. Finally, the State budget was frozen for a number of years.

There were two immediate effects for these reforms. The first is nominal GDP growth was savagely slashed: as it’s obvious, lower inflation meant nominal prices and asset values didn’t raise as rapidly as before, therefore exposing the “inflated” nature of ’60s and ’70s ROK economic growth. The second is standards of living throughout the country started to improve at a steady pace. A saner monetary policy led to a massive increase in saving rates and these savings became capital which was in turn used to increase productivity outside of the chaebol system. Privately-owned banks started to look for new customers and quickly found them in small businessmen and, even more critically, farmers. After being starved for credit for over two decades they desperately needed capital to improve their productivity and the new banking system, coupled with increasing saving rates, helped them to achieve the long-delayed mechanization of ROK agriculture.

Under Chun’s successors, Roh Tae-Woo and Kim Young-Sam, the process continued, accelerating under President Kim, the first Korean president with no military background.

And what of the chaebol themselves? In spite of all, they continued to prosper. Or at least they gave an impression of prosperity. Despite all the reforms, most of them continued the Park-era practice of taking massive loans without worrying too much about repayment. The banks may have become privatized but most of them had no problems lending huge sums to the chaebol, which were seen as a “sure bet”.

Between 1988 and 1989 a financial event which is still sending ripples to this day happened: the ’80s Japanese “Bubble Economy” burst. We’ll deal with this event in the future but for now suffice to say to prevent a complete meltdown of some of the largest keiretsu banks the Bank of Japan lowered rates to near zero “in perpetuity”, flooding these financial institutions with dirt cheap credit. This credit quickly found its way to Mainland Asia, especially in countries like India, Thailand, Malaysia and ROK. This credit bubble took two forms: the first is the so-called yen carry trade, by which banks borrowed money at near-zero rates in Japan and lent it at much higher rates in countries like India. The second were direct loans from Japanese banks to foreign customers, especially in Thailand, Taiwan and ROK.
This credit bubble fueled the so called Asian Tiger Economy, a period of tumultuous growth in the Pacific Rim (and India) which turned out to be a catastrophic and costly mistake.

On July 2nd 1997, Thailand’s Central Bank was forced to float the baht after “discovering” they had no foreign currency reserves left to protect the baht from a massive speculative attack. This move triggered a cascade of events which resulted in what was called the “perfect financial storm” although it looks like small fries compared to the present US and European financial crisis.

The causes of this colossal crisis were chiefly two. First, most Pacific Rim (chiefly ROK and Thailand) countries had fixed or semi-fixed exchange rates which, coupled with large current-account deficits, left their currencies open to massive speculative attacks. Second, the connection between very low interest rates in Japan and moderate to high interest rates in Pacific Rim countries led companies to borrow heavily abroad to fund very aggressive and very poorly supervised investments at home. As Jeffrey Sachs wrote about Pacific Rim financial institutions before the bubble burst “Banks borrow abroad and lend at home with reckless abandon”.

This crisis hit the chaebol system like the proverbial sledgehammer. Many of them had taken large unhedged foreign-currency loans and, with the won in a precipitous fall against foreign currencies, they faced impossibly high debt repayments in domestic currency terms. As the crisis unraveled, it was also discovered many chaebol, far from being the solid companies they pretended to be, had piled huge mountains of debts they had been able to hide from the outside world thanks to highly irregular accounting practices on which the ROK government had turned more than a blind eye for years. Out of the 30 chaebol, 11 were literally swept away by the Asian Crisis. Others were forced to sell valuable assets at rock bottom prices to avert a complete meltdown. The chief casualty was the Daewoo chaebol, the country’s second largest, which was completely defunct by 1999: some of its operations were closed down, others sold off to partially repay creditors and a few (notably the profitable shipbuilding division) were spun off and became independent groups. Even Hyundai, the largest chaebol by far, was forced to sell off core operations to remain solvent, even if barely so. Two chaebol emerged stronger from the crisis: Samsung and LG. Both had far better accounting and financial practices than their competitors and were also able to expand by buying patents, factories, machinery and whole operations at bargain prices.

However the clear winner of the crisis was ROK as a whole. In the aftermath of the crisis even the government understood the foolishness of over-reliance on the chaebol system and the weakness of a pegged currency. Although the Korean economy had started to see an expansion of small and the middle sized businesses in the’80s already, the true boom came after 1998. Today ROK has a much diversified economy, which has curbed reliance on traditional heavy industry and low value-added goods significantly. Middle and small-sized enterprises manufacturing capital-intensive goods, either born from the ashes of the defunct chaebol or newly founded, are now the backbone of the economy. Standards of living have soared and now ROK citizens are among the wealthiest in the world.

Not all that’s glitters is gold though: in the closing months of 2012 a series of major scandals hit a number of ROK banks, hinting at the existence of widespread corrupt lending and accounting practices. Times have changed though and, following public outcry, the ROK government was forced to take legal action against the responsible (or at least some of them) and will apparently allow the worst banks to fail. It may not be a perfect world, but at least ROK appears to have learned from her past mistakes. Confront with the US and Europe were failed banks are artificially propped up and, instead of being tried, bankers are still able to dictate monetary policies.

Perhaps we need an Asian Crisis of our own to learn as well…

* Korean Central Intelligence Agency. This was the Park-era secret police, intelligence and counter-intelligence agencies all rolled in one. It wielded tremendous powers and was responsible for terrible abuses. Following General Park’s assassination it was deeply reformed and renamed Agency for National Security Planning.


Haggard, Stephen (editor), Economic Crisis and Corporate Restructuring in Korea: Reforming the Chaebol, 2003, Cambridge (UK), Cambridge University Press

Sung-Hui, Chwa, Sung-Hee, Jwa, The Evolution of Large Corporations in Korea, 2002, Cheltenham, Edgar Elgar Publishing

Ten Years On: How Asia Shrugged off its Economic Crisis, The Economist, July 4th 2007

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