Republic of Dysfunction

By Henry Seggerman

Galaxy Note 7 smartphones are not Samsung Electronics’ first burning cellphones. Twenty-one years ago, Lee Kun-hee famously smashed and burned 150,000 malfunctioning cellphones in Samsung’s factory courtyard, to the wails of factory workers. On May 10, 2014, the tycoon suffered a heart attack. Lee has been hospitalized incommunicado since then. How is it that this massive conglomerate ― worth $300 billion, with nearly 80 affiliated companies, many owned by a super-majority of outside shareholders ― can get away with completely concealing the health of its supreme leader for more than two years?

Relative to family-controlled businesses in other countries, the Lee family owns precious little stock ― propped up by circular shareholdings ― in Samsung Electronics and big conglomerate affiliates. Transfer-of-control priorities absorbing the Lee family, which may have led to Galaxy inattention, have also set back corporate governance in Korea by decades. Korea’s largest pension fund, the National Pension Service (NPS), until recently marched in lockstep with chaebol controlling families, no matter how little stock the families owned, no matter how harmful their management was to ordinary shareholders.

Then the NPS got religion. It voted against re-electing Hyundai Motor Chairman Chung Mong-koo due to his criminal conviction. It formed a Council of Experts which decided NPS voting at annual general meetings, insulating NPS from politicized shareholder disputes. But along came the Samsung C&T/Cheil Industries merger, and the Council of Experts was nowhere to be found. NPS simply caved in to pressure. The merger pricing was not only patently unfair to Samsung C&T shareholders, but it also connects directly back to Lee Jae-yong’s original unfairly-priced purchase of his 25 percent Everland stake, multiplying the fraud exponentially. The purpose of all this, and NPS’ craven acquiescence, was to put Samsung C&T’s 4 percent Samsung Electronics’ stake into the hands of Lee Jae-yong.

Labor regulations are a fine thing. They protect workers from abusive employers. Labor and management should structure labor-management agreements which protect the workforce, but also ensure company stability, and reasonable prosperity for all stakeholders. After Samsung Electronics, Hyundai Motor is Korea’s second most important company. How is it that such a key manufacturer, which wins numerous awards in the U.S., has suffered a strike every year for five years? What is behind Korea’s tiresome pattern of failed springtime negotiations followed by summertime strikes, in so many industries? Do the workers just want some extra time at the beach?

Korea suffers from a rigid labor market. Lifetime employment is the rule; even if a division is failing, it remains extremely difficult for companies to lay off workers. Work for a day at one conglomerate, and you find yourself undesirable at all the others. As the “gig economy” prospers elsewhere, Korean companies are bound by stringent requirements to promote part-timers to full-time. Korea was proudly the first Asian nation to host the G20 Summit and has signed a whopping 25 free-trade agreements ― #2 after Singapore among 48 countries worldwide. So what is it about globalization that Korea fails to understand? Few nations have intrinsic skills in any one industry, so most industries naturally seek out the lowest unit labor cost, faster every day due to globalization. Huawei will be nipping at Samsung’s heels very soon, not just because of the flaming Galaxies, but also because of lower unit labor cost.

Korea should not be propping up any zombie companies or zombie industries. It’s very hard for a developed economy to succeed in heavy industry sectors like shipbuilding and shipping. Why postpone the agony? In the U.S., Obama got into trouble for saying “some of those jobs of the past are just not going to come back” about manufacturing, but he was telling the truth. Whether in Korea, the U.S., or any country, the response to globalization-related employment turmoil is labor flexibility, job retraining programs, and a decent unemployment safety net (sorely lacking in Korea) ― not further bailouts.

Korea, with a 2.7 percent GDP growth rate, looks on emerging market neighbors like China (6.9 percent) and India (7.6 percent) with jealous eyes. MSCI considers Korea an emerging market, so why can’t Korea enjoy emerging market growth? Once a year, there was always one Korean market sales trader, churning his accounts, who’d announce that MSCI was about to upgrade Korea to a developed market. After all, Korea’s per-capita GDP exceeds that of MSCI developed markets ― Italy, Spain, Portugal and New Zealand. But as with dysfunctional corporate governance and labor law, Korea failed here, too. MSCI removed Korea from developed market consideration, because it is judged too inaccessible to foreign investors. ETFs are the biggest thing to happen in fund management in the last 20 years, but ETFs’ large and off-exchange transactions are expensive and difficult to execute in Korea. The won is still not freely-tradable, and Korea’s ID system is antiquated. No developed market suffers these accessibility problems, all which Korea could easily rectify.

Korea is at a crossroads here. While it can’t hope to compete with China or India for growth, it certainly can regain Malaysia or Indonesia’s 4.7 percent growth rate. Korea perpetuates its disdain for the rights of ordinary shareholders, its rigid, timid labor laws, its zombie bailouts, and its miles of red tape strangling foreign investment. At the same time, globalization is pushing Korea’s “Miracle on the Han” manufacturing to more profitable waters. Caught between internal inertia and unstoppable external forces, today Korea is in danger of sinking to the stagnant growth rates of France (1.2 percent) and Belgium (1.3 percent).

Henry Seggerman is CIO of International Investment Advisers.