This 3 part series of articles appeared in the Korea Times in January 2000.

What Direction for Korean Economic Restructuring?

Part I: Chaebol vs. Transnational Perspectives

Last semester several of my students worked on projects about the changing global economy and the restructuring of the Korean economy. These issues were already on my mind, but discussing these matters with penetrating young minds stimulated me to sharpen my own views.

As I see it, there are currently two mistaken views about how to interpret the East Asian financial crisis and the seeming recovery of Korea and other East Asian nations. The complacent view is that the crisis itself was an anomaly brought on by short term forces that are not likely to reoccur. Reflecting the rapid recovery of 1999, President Kim, for his own political reasons, has declared the crisis over. There are many, particularly in the chaebol, who would like to think that means the need for systematic reform is also over, that government should get out of the way of business.

The other erroneous interpretation of the past two years is that the economic crisis was a sign that in order to succeed in the new global economy Korea must abandon completely the industrial policies that spurred Korean growth in the past generation in favor of an American-style economic model in which trade barriers are razed and government largely withdraws from the economic marketplace.

These two different economic theories reflect two different sets of interests. Market reformers and transnational business are pushing Korea to open up their markets, reform the chaebol system, and adopt western standards of corporate governance, reflecting their desire to penetrate the Korean market and reduce the subsidies to chaebol who compete with them in international markets. The chaebol, also appealing to market theory, resist government intervention in their affairs because they want to maintain their current dominant position within Korea.

The fact is both sides present a false picture of how markets will work to serve Korean national interests. The western version of market theory ignores the fact that without subsidies, trade protection, and other forms of state support, very few Korean companies would have the resources to successfully compete on a global scale and in many cases even in the Korea market. How many Korean auto companies would survive if the Korean market were truly open to western automakers and the Korean car companies had to compete without protection and subsidies? Already western car companies are grasping at the weaker Korean automakers. The chaebol exist because in the 1960s Korea recognized that it would have to concentrate resources on a few key units so that a small, weak country could create enterprises that could compete internationally. The Korean economy is no longer so small and weak, but the power of the western transnationals has also grown dramatically in the past decades. American economists may believe that it makes no real difference whether most advanced capital and consumer goods in the Korean market are produced by Korean owned companies or western transnationals, but most Koreans intuitively sense that in fact it does matter.

Now it is true that if transnational companies rapidly increase their penetration of Korea the few Koreans who work for them or invest heavily in them will prosper. But the more the West penetrates the Korean economy the greater income inequality in Korea will become. The distance between the living standards of different classes, sectors, and regions will be exacerbated. Just look at the effect of the recent financial crisis on the fabric of Korean society, as western-style lay-offs and corporate downsizing came to Korea. Or look at the social stratification in Latin America, an entire region of the world that for centuries has been partially developed but also partially underdeveloped under the domination of the western economies. Great wealth lives side-by-side with unspeakable poverty and entire economies are alternatively puffed up and then squeezed down by the fads and fancies of western investors. Koreans are justifiably aware of and proud of the rapid economic growth they achieved in the last generation, but perhaps they should be more aware of and proud of just how remarkable it was to spread this growth so broadly across most classes and sectors of society. No economy deeply penetrated by the West has ever maintained the kind of social harmony shown by Korea, Japan, and other East Asian tigers. It would be a shame to give that up for a couple of points of temporary economic growth.

The Korean chaebol who resist reform are just as disingenuous in their false version of market theory as the western transnationals who justify their penetration of the Korean market as good for Koreans. Of course the chaebol want government to leave them alone to operate without regulation, although they also want the government subsidies and protections to keep flowing. Of course the chaebol want to perpetuate the current system because they are the ones that dominate things as they are. But the recent financial crisis underscored the danger of just leaving the chaebol untouched under the pretext of letting market forces work. Under the current system market forces do not work effectively because of the huge advantages the chaebol have accumulated from more than a generation of subsidies and protections. After decades of cultivating and favoring the chaebol, for the government to now simply step back and let the chaebol operate uninhibited would mean ensuring chaebol domination of the system for at least another generation rather than true market competition.

The chaebol today have the best of both worlds. They are neither truly disciplined by market competition within Korea nor effectively regulated by the state. Of course, the chaebol operate within economic markets and of course there are a wide series of nominal government regulations. But the behavior of the chaebol is not effectively constrained by either competition or regulation. The chaebol have, in fact, become increasingly arrogant and unresponsive to real world conditions. The launching of Samsung Motors despite virtually unanimous outside analyses that another Korean auto company could not be sustained or the fevered overseas investments of Daewoo even as that empire was collapsing from within are only the most vivid indicators that the chaebol are no longer discplined either by state or market.

Now there are elements of truth in each of these distorted versions of market theory, however misguided they are overall. The defenders of the chaebol are essentially correct on two points--the chaebol are still crucial to Korea's economic success and the chaebol must operate more in consonance with market forces than they have in the past. However, the fiscal crisis alone nor the so far modest reforms in government policy have not truly restructured the chaebol, and without restructuring the chaebol cannot truly reflect market forces. Simply letting the chaebol alone to operate as they have in the recent past will neither subject them to the discipline of market forces nor make them more competitive on a global scale. The ultimate outcome of the self-serving policies advocated by the chaebol would be stagnating living standards for most Koreans and ultimately degeneration of the chaebol's own ability to compete internationally.

The western market liberalizers also have a point. Under the current system of massive, virtually unconditional subsidies to the chaebol and tight trade protection, the chaebol are not substantially subject to market discipline and thus will not make economically rational decisions. So the current chaebol waste precious resources and slow Korean economic growth. What the western market liberalizers fail to recognize or acknowledge is that without judicious subsidies and a moderate amount of trade protection, most Korean enterprises that now operate on a global scale will simply not be able to compete effectively.

Simply relying on markets is not enough for successful Korean industrial policy. Under current conditions the chaebol are likely to become less and less competitive internationally. However, the excessive liberalization sought by so many in the West in the name of reform would serve the interests of western transnationals more than the Korean people by undermining the ability of Korean enterprises to compete both in their home market and globally.

What Direction for Korean Economic Restructuring?

Part II: A Third Way?

My previous article argued that there are two dangers Korean industrial policy needs to avoid. The first is the excessive liberalization pushed by western transnationals and economists that will open the Korean market to domination by foreign firms and lead to great income inequality. The second is little or no reform of the current chaebol system, which the chaebol favor, which will mean excessively high prices and poor quality goods for Korean consumers, declining ability of Korean enterprises to compete abroad, and slowing long-term economic growth.

There is a third alternative to chaebol domination under cosmetic reform or caving into massive western penetration through widespread and thoughtless liberalization. But it would require greater intellectual clarity and greater political will than has been seen recently in Korea. Korea could return to the combination of focused state guidance of economic development coupled with market forces which was the key to Korea's successful industrial policies of the 70s and 80s. This third alternative is the kind of state-guided industrial policy that was characteristic of the period of rapid economic growth in Korea, although, of course, the exact content of state policies would have to be substantially changed to meet the new conditions of the new millenium.

Most observers in the West and many in Korea itself believe the recent fiscal crisis was a warning that the state-guided development policies followed by a generation by the many of the most successful East Asian nations must be abandoned in favor of economies widely open to international market forces and closely modeled after the American economy. In the 1980s it was hard to ignore the success of a new economic model pursued by several East Asian nations, including Japan, South Korea, Taiwan, most of ASEAN, and even China, although many American economists did. These nations did not follow a classical Anglo-American pattern of free markets, but rather a form of state-guided capitalism, incorporating some principles of the market but led by what was sometimes called the "developmental" state or the "hard" state. During the era of decolonization and the Cold War, many nations around the world had powerful authoritarian states that planned the economic and social path of their nations. However, the peculiar genius of the "hard" East Asian state was that it was successful in spurring economic and social development where most powerful states failed.

However, in the 1990s, the idea of the developmental state has been under sustained attack. The continuing woes of the Japanese economy which had been the most glittering success of the developmental state, compared with the sustained economic growth of the U.S., has taken some of the luster off the hard state model. The Soviet bloc had hardly been a good advertisement for state-led development, but its total collapse further strengthened the belief that there was no real alternative to western-style capitalism as so eloquently put in Francis Fukuyama's The End of History. But the biggest blow to the concept of the developmental state came with the East Asian financial crisis in which most of the successful examples of state-led development were thrown into a tailspin.

The mainstream view in the West is now that the successes of the East Asian developmental states were an aberration. It is widely believed in the West that the new conditions of globalized markets have made such success impossible to repeat in today's conditions. American economists in particular generally preach that the only choice of East Asian or any other governments that want to advance their nation is to adopt the liberal western economic model and place their bets on open market competition.

It is a fact that most third world states that have tried to tightly control their economies have failed to guide their nations to success. But the very reality that many East Asian states succeeded in 70s and 80s cannot be easily dismissed. The crucial differences between those "hard" East Asian states and most other Third World states can be identified. First of all, the successful East Asian states were not dominated by narrow interests. In much of the world, key industries, landlords, leading families, big businesses, or other narrow interests have been able to twist activist government planning to serve their wants and needs rather than those of the nation. But the "hard" East Asian states were able to resist the capture of public policy by such special interests. These states were smart--they had well-educated, professional bureaucracies and often a well-educated general public as well. There was a strong political party or else strong charismatic leadership which overshadowed the more narrowly focused local business and landed elites.

Despite the undeniable past successes of East Asian developmental states, today advocates of the free market argue that the world has changed and state-led development is no longer a viable option in an increasingly globalized, competitive world which requires nimble, quickly adaptive enterprises. There is some merit to that point, but actually what has changed the most is not the international environment but the relations between government and business within East Asian nations. In Korea, the government used to dominate the chaebol who were completely dependent on government subsidies and more indirect forms of public largesse in order to function. But now the chaebol are mature global players with vast assets, huge revenue streams, and broad access to international capital. With their very success, the original driving fear of the chaebol of being overwhelmed by much larger global competitors has faded, replaced by a complacency that the chaebol will always survive, if for no other reason than that they are too big to fail.

On the other hand, the tight focus of government policies imposed by authoritarian writ has been diffused by the democratization of the political process. Democratization has meant more voices are heard in the policy process, but it has also meant the chaebol have been able to shout the loudest. The chaebol have used the opening of the political process to increase the scope and scale of influence buying, finding many officials all too willing to be bought. As the chaebol became stonger, the government's ability to make policy as a unified actor weakened. Now the chaebol dominate the government. The government has lost the will to curb the excesses of the chaebol, both in the political arena and in economic decision making. The hard state has become the captured state.

What is needed today is a Korean government that is tough enough to resist both pressure from the West to liberalize too rapidly and robust enough to overcome chaebol resistance to any significant reform that unseats them from their comfortable perch atop the Korean economy. What is needed is a "rehardened" state, a state that is cognizant of its need to lead economic development, with the will to represent the interest of the greater Korean people rather than only those at the top of the economic pyramid here in Korea or around the world, and with institutions strong enough to formulate and implement such policies.

What Direction for Korean Economic Restructuring?

Part III: Can the Korean Government Cope?

In the second article in this series I argued that the best industrial policy for Korea would be to return to a revised form of the state guidance of the economy that was characteristic of the period of rapid economic growth in Korea. I am not offering a blueprint for what Korean industrial policy should or could be. Instead I have one simple point about conceptualizing industrial policy--that state guidance of the economy should not be abandoned in favor of simplistic ideas about the virtues of markets.

Of course state guidance of the economy is much more difficult in the contemporary environment than it was in the 70s. The twists and turns of the globalized economy are harder to predict than those of a generation ago, the Korean economy is much more complex than it was a quarter of a century ago, the chaebol are much harder to control than they used to be, and the Korean government is now constrained by democratic norms in policymaking. To effect a successful industrial policy in the 21st century would require more from a state that has been becoming weaker and less capable. Successful industrial policy in today's environment would require a "rehardened" Korean state. The state would have to be smarter than it needed to be a generation ago to deal with the greater complexities of the global system and the Korean economy. But more importantly it would have to get tougher on the chaebol and influence peddling politicians.

But wise use of state power is just as important now as it was in the 70s, probably more important. Although Korea is no longer a tiny economy with tiny companies, Korea still faces huge difficulties in sustaining enterprises that can compete with western transnational juggernauts on an international scale. If Korean enterprises are going to compete successfully the Korean government still must help them concentrate resources, although different resources, and provide the right infrastructure, although different kinds of infrastructure. Government must walk a thin line between: 1) allowing too much western penetration of domestic markets which would destroy the base that allows Korean enterprises to operate globally and 2) shielding the chaebol too much from true competition which makes them too secure and arrogant to be lean and hungry competitors overseas.

Wise state guidance of the Korean economy would recognize that both the western market theorists and the defenders of the chaebol have one valid point. The western market theorists are right that more market competition should be introduced to the Korean economy along with reform of corporate governance. The current chaebol are relatively immune from serious competitive pressure domestically. This not only means Korean consumers pay above market prices but also, the chaebol are weakened from operating in such a relatively closed environment which denies them the discipline needed to compete abroad. Gradual liberalization of selected markets to western penetration would be helpful as long as the pace is slow enough so that Korean enterprises are not quickly squeezed out of the picture.

The chaebol also have a point. Without them, Korean enterprises are unlikely to succeed internationally and evenually will lose many domestic markets as well. The policies which created the chaebol were based on an essential truth that enterprises from a relatively small and still less developed nation like Korea need many forms of state support to compete with massive American, European, and Japanese enterprises. What the defenders of the chaebol don't recognize is that the chaebol have to be streamlined and subjected to a certain amount of domestic market competition in order to get back into shape to successfully compete internationally.

State economic guidance needs to be more sophisticated today than it was a generation ago. Not only is the global market changing rapidly, but the chaebol have become entrenched and committed to a series of misguided business practices. A generation ago the state needed to create the chaebol out of thin air, now it needs to reshape existing organizations with great power to resist change.

Moreover, global markets are changing rapidly. Korean financial institutions in particular, always highly politicized, have fallen far behind the swiftly mutating global financial systems. On the one hand information technology has capital whipping much too rapidly and erratically around the globe, while on the other hand Korean banks and other financial institutions systematically misallocate precious capital locally. It will take great wisdom to reform Korean financial institutions to effectively read economic signals locally and also be somewhat responsive yet somewhat insulated to global trends and fads.

In the face of these daunting tasks, the state has less capacity to formulate wise policy than it did a generation ago. The corruption of officialdom has become endemic. Democratization has improved political institutions, but the Korean system lacks mature political parties that can formulate and sustain coherent economic policies. Western pressure to liberalize all segments of the economy simultaneously has made it more difficult for the state to find effective means to implement industrial policy. More broadly, the global fascination with the American economic model has made it more difficult to legitimate policies based on state involvement in economic decision making.

Kim Dae Jung's Big Deal plan was widely criticized in the name of free markets both in Korea and abroad. But the big deal plan was actually only a fraction of the dose of reform the chaebol need. The Kim administration was absolutely correct that one of the preconditions for the continuing viability of the chaebol is streamlining of their operations by concentrating on a few core businesses and ending their mindless pursuit of expansion at any cost. Certainly the Korea taxpayer should not be providing subsidized loans and other forms of support just so chaebol can drive more economically efficient small enterprises out of the Korean market. The wisdom of the early subsidies to the chaebol in the 70s was that they were targeted only to enterprises who performed certain key economic functions and were contingent upon success. But today the chaebol are so politically powerful they expect to be supported for any activity they undertake, regardless of whether it contributes to real economic growth or even whether they do a good job at it.

Is the Korean state up to the demanding tasks of wise guidance of the economy? Quite honestly, the answer today would have to be no. If the Korean political system doesn't have the will to impose the big deals on the chaebol, how can it muster the will for the more thorough reforms that are necessary? The state has become too soft and weak, too much at the beck and call of powerful industrialists here in Korea and overseas. Can the Korean state reform itself, "reharden" itself to resist chaebol dominance and pursue activist policies for the benefit of the broader Korean society? It is certainly possible, although there is little sign that the strong political party, the honest and motivated bureaucracy, and the other prerequisites of the strong state are coalescing at this time.

However, false theories of simply "letting the market work" and the costs of not "rehardening" the state should be known. Leaving the current distorted market alone will leave the bloated chaebol to remain economically inefficient in the Korean market and increasingly unable to compete successfully overseas. But the western notion of reform as rapid liberalization will put Korea increasingly at the mercy of forces far beyond Korea and undermine social stability here. Reform is necessary, but reform that returns to the principle of targeted state support only to those firms that are truly competitive at home and abroad.