November 20, 2017
Guest post by Gabriel A. Giménez Roche, assistant professor of economics at NEOMA Business School, and associate researcher at the Institut Économique Molinari
At a time when the nuclear menace of North Korea becomes increasingly serious, South Korea is also threatened from within by a series of high impact financial scandals. To face it, the government could be tempted to dismantle the famous chaebol—family-owned and managed conglomerates of industrial holdings. The cure would surely be worse than the disease, because the chaebol are still responsible for the much-admired economic success of the country. Moreover, reforms to improve financial transparency, and reduce incentives to fraud taxation can yield better results without jeopardizing the economy.
Earlier this March, a corruption scandal resulted in the impeachment and arrest of the South Korean president, Park Geun-Hye, followed by the sentencing of the heir of Samsung, Lee Jae-Yong, to five years in prison. Lee was convicted based on a judicial finding of corruption after a trial where the government failed to present any objective evidence of bribery—an outcome that points to a near certain conclusion that former President Park will be next. Lee had to be sacrificed to set the table for Park’s conviction that will help legitimatize the new government. This was just the newest episode in the ongoing conflict between the South Korean bureaucracy and the chaebol.
Consequently, the bureaucracy is emboldened by a wave of public protests and is now committed to a government crackdown on the chaebol themselves. State officials always feared that the size of the conglomerates could result in a too-big-to-fail situation rendering the economy vulnerable, thus threatening government finances in the eventuality of a crisis. However, the rags-to-riches success story of South Korean economic development after the Korean War is also the success story of the chaebol, and of how these conglomerates became an essential part of the world economy.
How could a miserable country of 20 million souls with a poorly qualified population and little financial capital have become a 50 million people economic powerhouse, at the vanguard of technology? Many would point out to South Korea’s strategic position between the Sea of Japan, the East China Sea, and the Yellow Sea, its abundant cheap labour, and American and Japanese investments in an area coveted by communist interests. Although these might have been necessary conditions for South Korean development, they surely were not sufficient. Many other countries in Asia, Latin America or Africa shared these features but to no avail. As usual, the explanation is an institutional one.
After the war, South Korea rapidly had to strengthen its military power as a deterrent to North Korea. It needed foreign exchange to pay off its debt to the USA, while also equipping its military. Thus, the dictatorships of Syngman Rhee (1948-1960) and General Park Chung-hee (1962-1979) had a choice before them: adopt either a centrally-planned economy or a market-oriented one. The former option, similar to North Korea, implied having to organize all aspects of South Korean economic, social, and military life. However, the government bureaucrats lacked the education or experience necessary for efficiently managing the economy. The founders of the chaebol successfully convinced the dictators that the second option would provide a faster solution.
The chaebol founders were entrepreneurs dedicated to foreign trade, and the production of cheap, basic products. As long as the chaebol met the broad economic goals of the government, they would keep its favour. This allowed the chaebol to concentrate on increasing their sales and market share abroad, without worrying much about finance, labour agitation, and foreign competition domestically. Since these goals concentrated on technology—necessary to secure South Korean military supremacy—the chaebol soon invested in all industrial sectors. As the chaebol grew, they enjoyed scale economies that gave them an edge over foreign competitors. By the 1970s, the chaebol were massive companies. Today, the total sales of the top 20 chaebol represent some 1.3 trillion dollars and 964 affiliated companies according to the Bank of Korea and the Fair Trade Commission of Korea. These same chaebol employ 1.23 million people in the world, with Samsung employing 265,000 people.
Although the too-big-to-fail argument is understandable, there are other ways of circumventing it without trying to break down the chaebol, and jeopardizing their market shares in global trade. In fact, the government should adopt measured reforms to improve financial transparency, and reduce incentives to fraud taxation. More financial transparency would mean more rigorous but also better and clearer accountancy practices that would reassure outside investors on performance and control. Indeed, more outside investors imply more monitoring of the activities of major shareholders—that is, the owning families of the chaebol—to secure better financial performance. Furthermore, more financial transparency would result in the formal compartmentalization of the different activities of chaebol. Consequently, owning families would favor a more professional management of their enterprises in order to secure the trust of outside investors.
The excessive Korean taxation on inheritance and gifts create a double incentive. For entrepreneurs wanting to keep their conglomerate structure intact, it is cheaper to bribe rather than pay the tax. For civil servants, accepting a millionaire bribe is more tantalizing than collecting multi-million taxes at just their wages. Instead, tax rules should be simpler and tax rates more modest, thus making bribes and penalties relatively more expensive than complying with taxation. Although such tax reforms would favor the owning families, their control is already dwindling as founding families are now in the third and fourth generation.
In conclusion, the problem today is not that the chaebol are family-owned, too-big-to-fail conglomerates. The problem is that regulation is either unnecessarily excessive when it should not, or insufficiently formal when it should. Simpler tax rules associated with more transparent accountancy rules could restrain the infamous excesses of the family management of chaebol. In this manner, South Korea can preserve the integrity of its leading companies while modernizing their management, without jeopardizing their position in global trade.