Washington, 14 January 1998 (RFE/RL) -- A leading Korean economist says that an alliance of secretive business cartels and politicians which he calls "crony capitalism" was a major factor behind the current financial crisis and remains the biggest challenge to reforming the Korean economy.
To some experts, this underlying situation carries a strong warning to the nations of Central and Eastern Europe and Central Asia which are now making the transition to market economies.
Before the crisis, South Korea was a leader among the so-called Asian Tiger economies. It was the 11th largest economy in the world, the 3rd largest in Asia. It was America's 5th largest export market, Japan's 2nd largest. It regularly recorded growth of six percent.
But that good performance was covering extremely bad problems. They were mere "cracks" in a facade that economic reformer Soogil Young says even fooled the Korean government. The Asian financial crisis, however, made the international investment community re-examine Korea and the cracks quickly became huge fissures.
Young is President of the Korea Institute for International Economy Policy, the leading Korean economic think-tank originally organized by the finance ministry and which still provides the government's main economic analysis. But it also does independent economic studies.
This week, Young told a Washington audience of economists, financial leaders and economic journalists that the Asian crisis has forced the country to face up to it's "crony capitalism."
Korean business has traditionally been dominated by large, secretive business conglomerates known as chaebols. Although publicly traded stock companies, they are usually dominated by one man or one family and are not subject to any of the usual rules of public accountability and transparency that corporations face in western countries.
Economists at the Institute for International Economics in Washington say the chaebols grew enormous corporate egos, each pushing to have a hand in every major business in the country no matter whether it made economic sense or was even viable.
Young says that because the chaebols were not subject to public scrutiny or accountability, they developed an excessive dependence on borrowing from banks and then diversifying their businesses recklessly with those funds.
Even worse, the chaebols set up financial linkages and inter-firm transactions within the conglomerates, using unfair inside transactions such as transfer of net profits and cross-subsidization.
Normal western corporate law would have exposed those practices, but Young says Korea's weak banking supervisory system let banks make unlimited loans to the chaebols, even though they had no idea how the businesses operated or their level of borrowing.
During economic booms, says Young, these kinds of cross loan guarantees within conglomerates could be covered over, but during downturns, it prevented unprofitable businesses from being sold off.
For example, he says, the Ssangyong Motor company -- part of Korea's bloated auto industry that has capacity far beyond demand -- couldn't be dealt with until all the other profitable companies in the Ssangyong chaebol repaid the troubled company's debts.
Even as this was going on, the head of a chaebol which was not in the automobile business was proposing to invest hundreds of millions of dollars to start a new car company.
Normal banking regulation would have prevented banks from lending blindly to these conglomerates, but says Young, lending decisions were being made on only two factors -- the amount of collateral, and political or corporate favoritism. Thus Korea's banks poured massive amounts of loans into chaebols based on the fame of their names, but little else.
At the same time, says Young, the leaders of the chaebols and Korean politicians developed chummy relationships that he calls "crony capitalism" that served to prevent, blunt or at least delay any serious effort to reform the chaebols, and Korea's system of government directed banking.
He says this crony capitalism contributed to the inflexibility of Korea's economy, stifled competition and suppressed the development of small and medium-size firms.
Korea's political system was democratized in 1987, says Young, but because the crony capitalism prevented reforms, militant groups of special interests like labor unions and farmers emerged -- groups which demanded ever more protections for themselves.
Thus Korean law prohibited companies from laying off workers without first getting court approval, a costly and extremely difficult procedure. All of this functioned so long as there were no strains on the system. But the Asian crisis prompted outside investors to take another look at the Korean situation. They saw how deep and significant the cracks were and quickly began pulling out.
As part of the International Monetary Fund (IMF) rescue package, Korea has agreed to severely restrict the chaebols, subject them to full public scrutiny and transparency, and impose strict banking regulations to prevent continued lending to these organizations.
The crisis, says Young, has forced Korea to deal immediately with the serious structural defects of its economy.
"Like it or not, we Koreans are now engaged in an unprecedented historic venture to reform ourselves," he said. "It is a war that we Koreans are waging with ourselves...as a rite of passage into the maturity of a truly developed economy."
Economic experts at the Institute for International Economics in Washington say the chaebol system and its close personal ties to bankers and politicians, without corporate transparency and strong banking system supervision, carry a strong warning to the nations in transition. In those countries, personal ties from the days of central planning are still very significant in the structuring of privatized companies and their connections to government leaders.
Officials in the transition nations, the experts say, must be careful that they don't let "crony capitalism" become the norm. Korea shows just how dangerous that can be in the long run.