South Korea's Economic Development: Achievements and Challenges
South Korea's remarkable economic growth, described as a "miracle" by Nobel laureate economist Robert E. Lucas, Jr., showcases the country's successful developmental strategy. Led by the government and centered around chaebols, large business groups, South Korea overcame institutional challenges through effective catch-up strategies and a unique rewards system. However, this growth also led to economic concentration by chaebols, posing challenges for sustainable development.
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INDUSTRIAL POLICY, ECONOMIC CONCENTRATION AND GOVERNMENTAL CAPTURE: THE KOREAN CASE Sangin Park Graduate School of Public Administration Research Center for Market and Government Seoul National University South Korea
Making a Miracle Robert E. Lucas, Jr., a Nobel laureate economist, called the economic growth of Korea a miracle in his Econometrica paper in 1993. In the 1960s, the size and distribution of population, school enrollment ratio, export items, and living standard of Korea and Philippines were about the same. However, from 1960 to 1988, Philippine s GDP per Capita increased at an annual rate of 1.8% while Korea s GDP per Capita increased at an annual rate of 6.2%. As a result, Korea s per capita income became three times larger than Philippine s in 1988. 2
Major Indicators of the Korean Economy, 1960 2000. Year 1960 1970 1980 1990 2000 2010 Population ( 000) 24,954 31,435 37,407 43,520 46,136 48,876 Per capita GDP (USD 2000) 1,109 1,879 3,462 6,390 10,546 16,372 Urbanization (%) 28.5 43.1 60.1 74.1 89.7 83.0 Share of Agriculture In GDP (%) 29.97 (in 1967) 29.25 16.17 8.94 4.63 2.56 Exports to GDP (%) 11.2 13.63 32.06 27.95 38.56 52.37 (in 1967) Gross Domestic Investment to GDP (%) 22.95 (in 1967) 25.36 31.81 37.51 30.56 29.14 Foreign Savings 83.3 34.7 35.7 2.4 -8.4 - to Gross Domestic Investment (%) (in 1962) Unemployment Rate (%) (Labor Force Participation Rate (%)) 11.7 (50.1) 4.5 (57.4) 4.1 (59.0) 2.4 (60.0) 4.1 (61.0) 3.6 (60.3) School enrolment, tertiary (%) NA 7.1 12.8 36.8 78.3 103.11 (in 1971) 3
Why has Korea been successful? Korea s Developmental strategy: Government-led, Chaebol-centered (chaebol is a large business group controlled by founder family in Korea) Effective in overcoming missing institutions of the financial market and the market for parts and components Efficient strategy for catch-up by imitation Merits-based reward system by providing a variety of business favors to high performing exporting firms The merits-based reward system, instead of relationship- based reward, is a unique characteristic of the Korean development. However, the economic development was accompanied with economic concentration by chaebols. 4
Top chaebols assets to GDP ratio, 2001-2017 100 90 80 70 60 50 40 30 20 10 0 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 1 5 10 30
Top chaebols sales to GDP ratio, 2001-2017 100 90 80 70 60 50 40 30 20 10 0 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 1 5 10 30
Top chaebols shares in market capitalization 2001-2016 70.0% 60.0% 50.0% 40.0% 30.0% 20.0% 10.0% 0.0% 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 1 5 10 20
The top four business groups are increasingly dominant The shares of top 4 business groups as a share of the top 30 groups in 2017 (2011 is shown in parentheses) ASSETS PROFITS Samsung Samsung Others: 30.6% (37.7) 4 groups : 52.7% (49.1%) 4 groups : 69.4% (62.3%) Others: 47.3% (50.9) Hyundai Motors LG Hyundai Motors SK SK LG Source: Yonhap News, 21 May 2017 8
Changes and Challenges Changes from economic development: The problem of missing institutions has been resolved by the growth of financial market and market for parts and components. Innovation led growth becomes more important than imitation led growth. The concentration by Korean chaebols leads to economic blocs by chaebol in which vertical integration, internal trading and exclusive sub-contracting are prevalent. Challenges from economic concentration by chaebols Relationship-based allocation and tunneling in chaebol. Price squeezing and IP extortion in exclusive sub-contracting Governmental capture, judiciary capture, media capture 9
Pervasive Related Party Transactions & Tunneling Intra-group trades and Tunneling in Korean chaebols 80% of chaebol group firms have intra-group trades between 2009 and 2017. These intra-group trades accounts for about 13% of the total sales. The fonder family s ultimate cash flow rights are 26% to 32% point higher in intra-group purchase firms than intra-group sale firms. Tunneling activities through huge RPTs between group firms of Korean chaebols have been so pervasive that new regulation on internal trades of chaebols was introduced into the Fair Trade Act in 2014 However, related-party-transactions have not yet been eradicated due to the insufficiency of legal provisions. According to a survey by the KFTC reported in June 2018,3 the proportion of intra- company transactions decreased temporarily and then increased again in the companies subject to the regulation since its introduction in 2013. Furthermore, the proportion of intra-company transactions has been maintained at a high level for the companies falling in the blind spots of the regulation. 10
Company profitability is influenced by intra-group trading The profit gap in group-affiliated firms, classified by intra-group trading shares in 2015 Profit gap1 1.0 Profit gap A. Intra-group purchases2 B. Intra-group sales3 3 2 0.5 1 0.0 0 -1 -0.5 -2 -3 -1.0 1. The profit rate in individual firms minus the profit rate in the business group to which they belong. A positive number thus means that a firm is more profitable than the business group. 2. The share of a firm s purchases from firms affiliated with the same business group as a share of their total purchases. 3. The share of a firm s sales to firms affiliated with the same business group as a share of their total sales. Source: Lee and Park (2016) 18
Monopsony and Exclusive Subcontracting (1) Increasing economy-wide concentration of chaebols and the consolidation by big chaebol firms in major industries For example, in the automobile industry, Hyundai Motors acquired Kia Motors while all the other three car-makers went into bankruptcy and then sold to foreign producers between 1998 and 2004. This merger and reshuffling led to local monopolization in the automobile market, establishing monopsony in the industry of automobile parts and components. Exclusive supply chains with suppliers of parts and components and engaging in price squeezing and IP (Intellectual Properties) extortion in the bargaining with its suppliers. No punitive damage nor discovery in place in civil lawsuits in Korea. SMEs lose both the incentive and the capacity to innovate, and are forced to compete in terms of price alone less subcontractors invest in research and development (R&D) if they are under exclusive contract (2015 Workplace Panel Survey) 12
Monopsony and Exclusive Subcontracting (2) As long as price squeezing provides an easy way for a big chaebol firm to guarantee its own price competitiveness, it has less incentive to push for innovation as well. Hyundai Motors had a cost advantage of at least 10 percent point over Volkswagen in the ratio of material costs to revenues in 2014. . Hyundai Motors ratio of consolidated sales to R&D spending is just 2.4 percent, while that of Volkswagen stands at over 5 percent in 2014. However, this price competitiveness started not to work any longer. price squeezing is reaching its limit in low-end models of automobiles the market share of Hyundai Motors in China plummeted from 10.4% in 2014 to 5% in 2017. lethargic innovations of carmakers and parts producers put the Korean automobile industry in jeopardy in the wake of connected car and electric vehicle The devastating consequences of monopsony on innovations were already observed in the U.S. automobile industry as illustrated in Saving Capitalism from the Capitalists, a book written by Rajan and Zingales. 13
Closed Innovation System: Korean firms are less connected to global innovation networks Firms engaged in international collaboration for innovation by firm size, 2012~14 Per cent 90 90 SMEs Large firms 80 80 70 70 60 60 50 50 40 40 30 30 20 20 10 10 0 0 1.As a percentage of firms engaged in product or process-innovation. For Korea, data are for 2013-15. Source: OECD (2017f), OECD Science, T echnology and Industry Scoreboard 2017
Monopsony and Inequality in economy-wide concentration In a society of economy-wide concentration by a small number of big business groups, the monopsony and the exclusive supply chain are the fundamental reason for the widening wage gap between workers at SMEs and those at big chaebol firms. According to the Korea Small Business Institute the wages at small-sized workplaces (with 10 to 99 employees) are 57.2% of those at large workplaces (with more than 500 employees) while the same measure of wage gap is only 83.8% in Japan in 2017. This wage cap mirrors the price and profit squeezing by the large monopsonist on small subcontractors in Korea. As shown by the Korean Metal Workers Union, in 2014, Hyundai Motors, the monopsonist, enjoyed an 8.5% of operating profits. In contrast, operating profits were 5.8% at large primary subcontractors, 3.8% at primary medium- sized subcontractors, and 2.8% at small subcontractors in the secondary tier, respectively. The wage gap between SMEs and large firms is a key element of widening income inequality in Korea. 15
Wage inequality is high and increasing Ratio of the 90thpercentile to the 10thpercentile Ratio Ratio 5.0 5.0 1990 2016 4.5 4.5 4.0 4.0 3.5 3.5 3.0 3.0 2.5 2.5 FRA JPN AUS DEU GBR OECD CAN KOR USA 16 Source: OECD Earnings Distribution (database)
Manufacturing Sector Crisis since 2011 Indicators for The Decline of Competitiveness of the Manufacturing Sector - Manufacturing has been the leading source the economic growth of Korea and accounts for a large portion of the Korean economy (30.2% of GDP, 2014) - But the growth rate of the manufacturing sector recently dropped to an overall economic growth rate since 2012. - Korea s rank both in the Global Manufacturing Competitiveness Index and the Trade Specification Index has dropped in manufacturing industries, especially in non-IT manufacturing industries, since 2012 - The profitability of manufacturing industries has been on a downward trend since 2011. 17
Export growth has decelerated sharply Export growth at an annual average rate in per cent Source: OECD Economic Outlook: Statistics and Projections (database).
Chaebol and Brandeis Approach The Korean chaebol became bigness as in the beginning of 20th century U.S. - the concentration of economic and political power in the hands of the few. Serious governmental capture, judiciary capture, media capture are observed Fighting bigness has been failed in Korea. The chaebol regulations were introduced into the Fair Trade Act in 1986. However, the regulations had loopholes from the beginning and were loosened later on in the name of economic vitalization. Chaebol reform recommended by IMF in the Korean Crisis in 1997 was transformed into the adoption of US-style corporate governance without any structural remedies on the economy-wide concentration by chaebols. The consolidation by big chaebol firms in major industries was accelerated after the Korean crisis in 1997. 19
Governmental Capture Samsung clause in the law 3% rule in the Insurance Act: an insurance company shall not have affiliated firms stocks and bonds whose combined values exceed 3% of its assets. However, affiliated firms stocks and bonds are valued at the acquisition prices while its assets are based on market prices by the Enforcement Guidelines. Because of this, Samsung Life Insurance can hold about 8.5% shares of Samsung Electronics. In 2007, which is near the end of term of the Roh Moo-hyun Administration, the economic concentration of chaebols increased sharply due to chaebol de- regulation. Moon Jae-in Administration has shown consistent passivity in implementing the pledged chaebol reforms since taking office. It has only persisted in urging the chaebols to voluntary resolve their economic concentrations. Even worse, the Moon Jae-in Administration has been pursuing pro-chaebol policy since the 2018 local elections. Last year, the special law on internet-only banks was enacted, breaking the principle of separating banks from non-financial firms. It is also actively considering the introduction of dual-class shares in the name of venture fostering. 20
Shareholding Structure of Key affiliates of Samsung Group (As of Dec. 31, 2019) Samsung C&T Corporation Co., Ltd (31.43% ; 33.13%) 5.01% 19.34% Samsung Electronics (5.79% ; 20.90%) Samsung Life Insurance Co., Ltd (20.82% ; 47.03%) 8.51% 14.98% Samsung Fire & Marine Insurance Co., Ltd (0.09% ; 18.51%) 1.49% Note: The percentage of its common shares held by ( founder family ; insiders )
three-five rule: a three-year prison sentence whose execution is suspended for five years and then is exempted if no further violations occur during the suspended period. 22
Judiciary Capture too big to jail in Korea. the founder families of chaebols typically escape indictment or conviction of crimes. Samsung Group s chairman Lee Kun-hee s 2009 trial is a real shame. The Supreme Court of Korea overturned the High Court decision and delivered Lee Kun-hee guilty verdict on the issuance of Samsung SDS bonds with warrant. . However, in a later sentencing trial, Seoul High Court acknowledged Lee s guilt but did not change his sentence, thereby confirming the suspended sentence. This judicial favor paid off for this trial s head judge, Kim Chang-seok, who was appointed as Justice of the Supreme Court in 2012. After the trial ended, a son of Jo Jun-ung, the Special Prosecutor of this case, joined Samsung Electronics as a section chief. Lee Jae-yong s trial like a d j vu of his father s 2009 trial? The judiciary capture is closely related to judges career concerns and opportunities in Korea. Many judges in their 40s or 50s typically quit when they are not promoted to higher ranked positions in the judiciary system. These early-retired judges typically join legal teams of chaebol firms or law firms whose big clients are chaebol firms. When particular families control a significant portion of a country s economic resources, judges with career concerns are likely to end up with judiciary capture. 23
Media Capture warm breeze on business Following the appellate court decisions in favor of Lee Jae-yong, some newspapers adopted a so-called frame of warm breeze on business and poured out reports supporting the court decision. Media s advertising dependence on chaebols The proportion of total advertising spending by the companies affiliated with the top five chaebols among the top 100 advertisers was 35.88% from January to September 2018. Particularly in the case of newspapers, the top five chaebols spent 37.25% of the total advertising costs of the top 100 advertisers. Among them, the advertising costs of Samsung- affiliated companies accounted for the highest proportion of 12.79%. According to a journalists consciousness survey conducted in 2017 by the Korea Press Foundation, 74.2% of field reporters picked advertisers as the most important factor that directly/indirectly restricts freedom of press in South Korea. Marriage between chaebol founder family and media owner family. Samsung and Dong-A Daily Newspaper, Samsung and Joonganong Media group. Journalists career concerns. A chaebol-friendly stance promises a variety of future benefits: For example, journalists get post-retirement positions in chaebol-affiliated institutions. Journalists in Korea typically quit in their 40s and 50s. 24
Conclusion The Korea is now at a cross-road. An economic crisis may not be avoidable in the near future without fundamental changes in economic structure and policies. Chaebol reform is the key for these changes. 25
