Now that China has grown to be the dominant economy in Asia, analysts sometimes forget that South Korea’s economic rise is perhaps the most impressive growth story of any country in Asia. In the 1950s, South Korea was one of the poorest countries in the world. It had suffered from both colonialism and a brutal and lengthy war that ended up splitting the country in two. The country’s extraordinary economic growth from the 1960s onwards was driven by the large family-owned corporations - some of them now global brands such as Samsung, LG and Hyundai – that are known as chaebols. The chaebols still dominate the South Korean economy - the five largest (Samsung, Hyundai, SK, LG and Lotte) account for more than half of the country’s benchmark Korea Composite Stock Price Index (KOSPI). This dominance is regarded by some economists as now detrimental to the Korean economy, however much the companies may have acted as drivers of growth in the past. The chaebols are criticized as overly cautious and hierarchical, suppressing the innovation that could come from smaller enterprises, and often seen as exercising corrupt influence over Korean politicians. In addition, as management is concentrated on the owner and the owner’s family, the chaebols are inefficient; they also abuse their dominant position through ‘gap-jil’, a South Korean term for the bullying of firms lower in the economic hierarchy.
The current centre-left administration of President Moon Jae-in came to power with a promise to reform the chaebols and restrain their influence both economically and politically. But the chaebols have proved to be more tenacious in holding on to power than many had expected. How much has Moon really achieved and should foreign investors be cheering him on or concerned about his chaebol reform programme?
Moon started off his campaign to rein in the chaebols in aggressive fashion by appointing Kim Sang-Jo, a former shareholder activist known as a “chaebol sniper”, as South Korea’s Fair Trade Commissioner in May 2017. Only 14 months after appointing Kim as the Fair Trade Commissioner, however, Lee Jae-yong of Samsung accompanied Moon on his state visit to India. This was particularly surprising as Lee had been initially imprisoned and then, after appeal, given a suspended sentence on corruption charges. To some liberal pundits this was a clear symbol that the Moon administration had given up on reforming the chaebols.
Moon’s economic policy
In his campaign President Moon pledged to boost the economy through three main strategies: income-lead growth, innovation-lead growth, and a “fair economy”. The first step in this policy was a bold experiment in raising the minimum wage. In addition, this year the finance ministry proposed an increased national budget of KRW 470 trillion for 2019, which included a 22% increase in funds allocated to create jobs. To address inequality the government also laid out plans to impose tougher taxes on property ownership to rein in a supposed real estate bubble.
With regard to innovation-lead growth, though, the government is showing little progress. Many economists believe that South Korea should fundamentally re-orient its industries towards “value-added” technologies or risk being hollowed out by competition from China and India. Chaebol reform, and other policies to address widening inequality, even if successfully completed, are merely half the goal.
On 27 September 2018 Kim Sang-jo, the Fair Trade Commissioner, targeted one issue in particular in dealing with the chaebols in an interview with Joongang Daily, a South Korean national newspaper: intragroup deals. These deals, which typically favour affiliates owned by family members at the expense of third-parties and minority shareholders, are often used to cement family control during periods of succession from one generation to another. Although such deals are already regulated, some listed affiliates of chaebols are called “blind-spot companies”, because they do not fall under current regulations (the term refers to those affiliates where the shares owned by the family are between 20 and 30% of the total). So far, the Fair Trade Commission has identified more than ten South Korean conglomerates engaging in such potentially unfair intragroup deals. Another target is the family-run charity foundations allowing chaebols to retain control of their sprawling empires or carry out irregular family succession without paying inheritance taxes.
Some change is undoubtedly taking place. In June last year Kim asked the “big four” chaebols – Samsung, Hyundai, LG and SK – to get rid of their shares in unlisted affiliates and reform supply-chain pyramids, widely believed to be an example of gap-jil (i.e. bullying suppliers). Afterwards, SK group came up with a KRW 160 billion fund to pay second and third tier subcontractors directly if a first-tier supplier were to be temporarily cash-strapped. As of September 2018, Lee Jae-yong has also completely eliminated the circular shareholding structure within Samsung. Chung Eui-sun of Hyundai is also under pressure to do so.
The responses of the chaebols have been criticized as cosmetic, however; firms such as Samsung, Hyundai and Lotte are increasing their transparency and improving corporate governance, but some believe that the chaebols have overall yielded little ground to shareholders. Intragroup deals within companies actually increased last year, and reports suggest that they happen more often in companies where the second-generation family-owners hold shares.
Proponents of the reforms argue that new rules, currently under review in the National Assembly, on holding groups, intragroup deals, and charitable foundations, will produce more changes for the chaebols but there are reasons to be skeptical. Firstly, a number of organizations are against the proposed amendments. Financial organizations such as the Korea Chamber argue that such regulations are unnecessary while civil organizations debunk the amendments as “abandoning chaebol reform”. Secondly, the amendments appear to have a number of potential loopholes that may allow the chaebols to evade their intended aims. Thirdly, the government lacks an absolute majority in the National Assembly, so it is unclear whether the amendments will make headway. The ongoing détente with North Korea has also shifted the focus from chaebol reform to security issues and has given the chaebols additional leverage as they would be required to rebuild North Korea’s infrastructure if the policy of engagement leads to greater economic links (and if sanctions are at least partially lifted).
Foreign investors have been following the progress of reform with keen interest as the chaebols have previously been successful in preventing foreign shareholders from blocking what were perceived of as unfair intragroup deals. A notorious case during the previous administration of Park Geun-hye involved Samsung and the hedge fund Elliott Management. Elliott is now engaged in a dispute with Hyundai over a somewhat similar situation, in which the latter had proposed an intragroup deal in connection with a succession plan. In May of this year Hyundai was forced to abandon its restructuring plans due to pressure from investors including Elliott. This seems to suggest that pressure can now be brought against unfair deals; since the vote, however, the situation seems to have evolved into a form of stalemate as Hyundai has dropped its original plans but has not accepted Elliott’s revised proposal. The eventual result of the Hyundai dispute will be one indication of whether the role of the chaebols has really changed under the Moon administration.