Unleash animal spirits of smaller firms

By Robert Edwin Kelly

The Financial Times recently argued that Korea is becoming a two-tiered economy. Chaebol, employing less than 10 percent of Korea’s workforce, are pulling away from the life of regular Koreans and the small and enterprise sector (SME) where most work.

Sharp inequalities of wealth are common in capitalism of course, but Korea’s extraordinary corporate structure worsens these inequalities in ways that can be easily rectified and bring Korea into greater compliance with OECD best practices. Specifically, the excessive concentration of market power, and, inevitably, political influence, in the hands of massive, cross-sectoral conglomerates spreads oligopolistic bad practices across far too many sectors of the Korean economy.

Any textbook in economics could predict that such concentration would lead to low innovation, high consumer pricing, political corruption, intra- and even cross-sectoral collusion, generous informal access to the national budget, and a “too-big-to-fail” mentality.

The sheer bulk of chaebol gives them inordinate, collusive political influence. The most obvious mark of this is the pardons extended to top chaebol executives convicted of crimes. More important is informal government pressure on Korean banks to loan “upward” to big firms at generous rates. That not only encourages recklessness at the top, it squeezes SMEs at the bottom.

Most controversially, chaebol terrified the Korean state and taxpayers into picking up the bill of the 1997-98 Asian financial crisis. It should really be called the “chaebol crisis,” because it was not caused by reckless sovereign or household borrowing, nor by the International Monetary Fund (IMF), but by chaebol access to Wall Street and consequent wild over-borrowing and misinvestment. Yet, conveniently, Korea’s biggest companies transferred their debt to the state (i.e., taxpayers), which then had to approach the IMF.

Koreans traditionally blame the IMF for the crisis, but it was, in fact, because the Korean state nationalized the debt of Korea’s corporate sector. This is why the primary IMF condition was de-concentration of the commanding heights of Korea’s economy, a practice chaebol have fought ever since. Today, e.g., the Bank of Korea continues to “fine-tune” the exchange rate at the behest of mega-exporters, with the obvious downside that import prices for consumers remain unnecessarily high.

There’s more. Chaebol are not only oligopolists in one sector. They frequently use cross-sectoral holdings to leverage success in one sector into success in another, such as SK’s position in the unrelated sectors of telecommunication, real estate, and gas stations. A well-known example for Westerners is Microsoft. For more than a decade, MS used its power in operating systems (Windows) and office software (MS Office) as leverage to crush rivals in other areas where MS was weaker ― browsers (Netscape), instant messaging (ICQ), media players (WinAmp), etc. This predation was eventually stopped when the U.S. government threatened to split MS. In Korea, this process is much wider and unregulated, resulting in behemoths that are not only within-sector, but also cross-sector, oligopolists.

This manner of “robber-baron” capitalism disappeared from the West a century ago in the progressive era. Even Adam Smith rejected excessive concentration, and I can think of no market explanation whereby SK credibly synergizes telecom, real estate, and gas station chains. These outcomes are so blatantly political and can be so easily unraveled by corporate governance practices well-established elsewhere in the OECD, that I am amazed Korea sees so little populism.

In contrast to high-end oligopolization, the Korean household sector saves less than 3 percent and carries debt around 150 percent of income. Korea’s SME sector is so starved for bank credit that the current administration is basically pleading with chaebol to forego competition. Bank credit for SMEs is “crowded out” by upward soft loans; Korea’s SMEs have no such informal political safety net. Anyone walking down the same street in Korea for more than a year or two can see the dramatic merry-go-round of small business here. Korea is filled with mom-and-pop stores just one or two bad months away from bankruptcy.

But there are market-friendly answers that do not require the government to forcibly delimit some areas for the SMEs and some for chaebol, nor to beg the chaebol to be nice:

Halt easy credit for chaebol, while creating a pool of such capital for small business, modeled on the U.S. Small Business Administration. The Korean SME sector is the most dynamic economic force in the country, taking huge risks to build neighborhood-enriching corner shops. This is far gutsier than mega-companies with lots of government buddies producing variants on the same product every year.

The Korean Jeff Bezos or Mark Zuckerberg is out there, but I guarantee he is not a mid-level salary-man at Samsung. The government needs to unleash the “animal spirits” of Koreans; access to bank credit on an equal playing field is the obvious place to start.

Enforce antitrust law. Oligopolies create so many negative effects that even the conservative Reagan administration broke up AT&T and achieved a 70 percent reduction in long-distance rates. There is no possible economic justification for consumer-punishing cross-sectoral conglomerates. Western regulators would long ago have forced chaebol spin-offs. More firms mean more competition, more innovation, and lower prices.

Stop sterilizing the won’s appreciation. “Fine-tuning” is a hollow euphemism for forcing depreciation at the behest of chaebol exporters. It creates obvious costs ― 5,000 won for an import beer at HomePlus ― for consumers. Korea’s inflation rate is now 4.2 percent; an easy way to return purchasing power to Korean consumers would be for the currency to rise.

Robert E. Kelly is an assistant professor in the Department of Political Science and Diplomacy at Pusan National University. More of his work may be found at his website, AsianSecurityBlog.wordpress.com.