South Korea’s Corporate Giants Under the Gun

South Korea’s chaebols played a crucial role in the economic rise from war-torn resource-poor former colony to a country with a per capita gross domestic product (GDP) of more than $30,000. Samsung Electronics, Hyundai Motors and others have over the years been a source of pride for South Koreans.

But they are now being urged to reform, considered guilty of corruption and fostering inequality. They are especially criticized for their corrupt relationship with politics, illegally favoring their own subsidiaries, engaging in unfair contracting with small- and medium-sized enterprises and extorting patents from their suppliers. The clamor to reform them has been loud since the 1980s, but it seems to have become even louder since the inauguration of the Moon administration in May 2018.

The chaebol have themselves to blame. They were successful in achieving rapid growth thanks to full government support. But reckless borrowing, indiscriminate expansion and shaky financial structures helped to trigger South Korea’s suffering during the Asian financial crisis of the late 1990s. This is why the financial crisis led to full-scale reforms.

In the wake of the 1997-1998 Asian financial crisis, 19 of the top 30 chaebol, a full two thirds, disappeared or shrank. Eleven dissolved and eight fell out of the top 30. The 11 that survived became large corporations in the global market. The top five, including Samsung, are quite dazzling.

The surviving best of the large corporations were able to achieve rapid growth, while the weakest went under. The gap among large corporations was not that large in the early 1990s, but this changed completely in the 2000s. Front-running corporations such as Samsung grew rapidly while lower ranking corporations made slow progress, at best.

Culture and Behavior of Large Conglomerates

It is true that the growth of new and traditional large corporations has been regarded as a blessing for the South Korean economy. When export-oriented large corporations grow, the effect should trickle down to SMEs, so there were expectations of job creation and expansion of household income.

But after the globalization of the 1990s, large corporations in South Korea began a policy of offshoring, moving production and sales bases abroad to overcome tax barriers and to ensure price competitiveness. Only core personnel such as research and development and management were left in South Korea.

As a result, there was growth without employment, where even with high growth at large corporations, jobs were not created domestically.

Problems such as unequal and unfair transactions between large conglomerates and their suppliers, mostly SMEs, including slashing prices and snatching patents from suppliers, were prevalent. This gave rise to situations where even the survival of SME suppliers was threatened, and few of them had opportunities for expansion. Although the worsening competitiveness of SMEs cannot be blamed on large corporations, it seems clear that unequal transactions with large corporations have been obstacles to the growth of SMEs.

On top of this, illicit and unlawful acts, and abuse of power by the families that control large corporations also exist. Starting with the “Nut Rage” incident, in which an heiress went out of control on a flight, and which exposed the abuse of power by the Hanjin Group’s controlling family, the Lotte Group and Hyosung Groups’ lawsuits between brothers or between father and son, and various instances of favoring subsidiaries illegally among owning families to avoid inheritance and gift taxes has generated indignation among South Korean citizens.

Reform Policy and its Limitations

While this spurred demand for reform of large corporations, the Moon administration came into office without preparation and passed its first year idly. There was confusion around whether “income-led growth” centering around the chief presidential policy adviser Jang Ha-sung, or “innovative growth” centering around Minister of Economy and Finance Kim Dong-yeon was the better option.

It is a relief that Kim Sang-jo, the head of the Korea Fair Trade Commission, who also holds the reins over reform of large corporations, achieved meaningful results in halting cross-subsidiary shareholdings, regulation of internal trading by subsidiary companies, and illegal subcontracting practices.

The Moon administration, reaching the middle of its tenure, has shifted its focus to “innovative inclusive growth,” and is again strengthening its determination to pursue reform of large conglomerates. The core of these efforts is to improve the corporate structure of large conglomerates, cutting fraudulently obtained private benefits such as favoring their own subsidiaries illegally, internal trading, and illegal subcontracting practices.

In other words, the aim is to improve the corporate structure of large conglomerates and to achieve a “fair” relationship between large conglomerates and SMEs. Is South Korea heading in the right direction?

President Moon and his economic advisers uniformly emphasize that there is “no trickle-down effect,” but this should be examined in detail. One relevant academic concept is the “forward and backward linkage effect.” Kim Sang-jo, head of the Korea Fair Trade Commission, emphasized in his book The Non-stop South Korean Economy (in Korean) that forward and backward linkage is very high in manufacturing, especially in industries such as automobiles and shipbuilding, where obtaining parts through sub-contractual transactions is common.

In South Korea, 70 percent of SMEs are involved in sub-contractual relations, meaning that recession in forward companies can massively influence companies that are further back in the supply chain. This can be seen when considering how much the recent slump of large corporations in the automobile and shipbuilding sectors has affected subcontracted SMEs. It is, therefore, a risky gamble to announce that there is “no trickle-down effect” and to unilaterally abolish the economic policies that are centered on larger corporations.

Another point has to do with an incorrect perception of investment. The economic advisers of the Moon administration uniformly state that South Korea’s investment ratio compared to GDP is No.1 in the world, claiming that there is no longer a need for investment in large corporations. Is this true?

Looking at R&D compared to sales, the top corporations in South Korea lag far behind top global corporations, except for Samsung Electronics. Even for Hyundai Motor and Kia Motors, the ratio of R&D to sales is half that of Japan Toyota’s, and was last among the top 10 automobile manufacturers. In other industries, this comparison is even worse. It is common sense that R&D investment in large corporations leads to competitiveness in the mid- to long-term.

The final point to emphasize is whether it is right to judge the size of a company as the standard for being a virtue or a vice. According to research on the illegal favoring of subsidiaries, among the top 100 family-owned South Korean companies, lower-ranked groups were more seriously involved in the illegal favoring of subsidiaries to obtain private gains than the largest ones. This is also true for abuse of power by the controlling family.

Samsung and Hyundai Motors, the top companies, are monitored by civil society organizations such as People’s Solidarity for Participatory Democracy and by institutions such as the Korea Fair Trade Commission, the National Tax Service, and the Prosecutor’s Office. However, smaller groups and SMEs reside in a blind spot, so the problem there is more severe.

Recent fact-finding research by the Korea Fair Trade Commission and the National Tax Service produced similar results. It is unreasonable to consider unequal transactions with subcontractors and the involvement of controlling families in the illegal favoring of subsidiaries to obtain private gains to be solely problems of large corporations.

Respect for Innovation, and Achieving Social Values

Discussion on the current South Korean economy cannot focus solely on exports, large corporations, growth, and investment, and at the same time cannot merely focus on resolving inequality, job creation, and the plight of SMES. The government’s role is to interpret the problem at hand in a complex and neutral manner and achieve complex policy objectives through an optimal policy mix.

If the government’s policy flows in a single-tracked and dichotomous way, social conflict will be aggravated, and initial policy aims will not be reached, because efforts will be expended on resolving social conflicts. Large corporations should change. They should stop thinking that their role ends with “profit creation” and “leading growth.” They should realize that their past successes were only possible due to the full support of past administrations, and they should go beyond profit creation and become leading actors in creating shared value.

It is a positive development that companies such as Samsung and SK are restructuring their overall businesses from a social value creation perspective. Corporate growth is important, yet it is more important not to damage or destroy common social values. A “bad company” that loses the trust of consumers and the public cannot survive in the long-term.

Jae-kwon Park is the managing director of CEO ScoreDaily, which specializes in corporate analysis. This was written for the Seoul-based think tank East Asia Foundation. The views expressed here do not reflect any official position of the East Asia Foundation.