In the Korean presidential election this year, economic democratization is a popular topic and chaebol (South Korean form of business conglomerate) reform has been proposed. In order to understand Korean chaebol and economic democratization, The reporter interviewed Hong Y. Park, professor of economics at Saginaw Valley State University, US.

Chinese Social Sciences Today:  Prof. Park, would you like to explain how chaebol was originated and what’s its roles in promoting the industrialization in history and the IT economy?

Park: The prevalent form of business firms in Korea is chaebol, which is a diversified conglomerate.  After World War II, Korea was liberated from Japanese control and Korean entrepreneurs, knowledgeable of Japanese forms of business firms, adopted a similar form of business organization as that of the Japanese Zaibatsu.

The Korean economy has made rapid, successful economic growth over a very short period. Korean government and chaebols played leading roles in different periods such as labor intensive manufacturing in the 1960s, heavy industries and chemicals in the 1980s and IT and electronics in the 1990s. Korean government played an important role in construction of infrastructures for these transitions of industrial structures. Samsung, LG and SK played important roles in developing IT technologies and electronics. Samsung and LG are leading players in IT and electronics and have become household names in the global market. Samsung is a leading memory cheap supplier in the world, for example. Owners of these chaebols made huge capital investments in IT and electronics and in so doing also they took risks since they were just emerging as new industries and therefore the future successes of their investments were uncertain.  Fortunately, they were successful. These results show that the foresights of business and government leaders are crucially important in nations’ economic transitions from labor intensive to heavy industries and IT industries. Successful economic transitions in turn contributed to economic and firm growth.

Chinese Social Sciences Today: In your article, “Advantages and Shortcomings of Korean Chaebols” in 2008, you discussed pros and cons of the chaebols, four years have passed, do chaebols still keep their advantages and have they made any progress overcoming their shortcomings?

Park: In my 2008 article I listed advantages and shortcomings of chaebols based on my survey of Korean companies.  Advantages of chaebols by survey respondents in descending order of importance are:  1) easy diversification in business with an established reputation, and recognition of chaebols’ brand name; 2) scope economies by synergy effects; 3) scale economies by large size; 4) improvement in decision making by having cumulated knowledge and experiences of many business executives in a chaebol; 5) improvements in capturing new business opportunities with vast knowledge in many fields of business.       Shortcomings of chaebols in the descending order of importance are: 1) lack of transparency; 2) high risks of business due to the CEO’s autocratic decision making; 3) increase in exit costs by losing timely exit of unprofitable businesses; 4) increase in management costs due to bureaucratic organization; 5) inefficient resource allocation due to non-market internal resource allocation; 6) lack of timely decision making and adaptation; 7) delay of development in core capabilities. 

Yes, chaebols continue to diversify by vertical integration, mergers and new ventures.  Korean governments are trying to curb their diversification on new ventures, particularly in the areas where small and medium size companies can do the job well.  Their brand name recognition is growing and Samsung, Hyundai, LG, POSCO, SK, Lotte, Hanwha, Hanjin Korean Air, Kumho Asiana and Doosan are becoming household names in the global market. However, Woongjin and Kumho got into trouble lately during a bad timing of economic downturn after acquiring construction companies and expanding into construction business even though they lacked expertise in the field.
Korean chaebols are overcoming the lack of transparency. Korea became a democratic government and their policies became more transparent and the political changes also spread to chaebols as employees and the public demanded transparency in leaders’ decisions. Chaebols are becoming democratic organizations. Law and regulations prohibit cross-subsidy for a poorly performing business unit in the chaebol because the poorly performing business unit brought down the whole chaebol during the 1997 economic crisis. Korean chaebols have become global companies and shareholders are spread globally. Shareholders from institutions monitor more closely behaviors of chabols’ CEOs and managers.

The collapse of a chaebol has significant impact on the chaebol itself and the economy.  Korean chaebols recognized the importance of core capabilities as they were going through the 1997 economic crisis. Their R&D expenditures have increased dramatically in recent years. Exploration of new knowledge and exploitation of existing knowledge received more keen attention from chaebols and the Korean government. CEOs of chaebols are beginning to pay attention to employees’ ideas more as knowledge became the most important contributing input for chaebols’ success.  IT technologies help them have access to information and voices from all stakeholders of chaebols such as consumers, shareholders, scientific community and the public in the knowledge economy. Recently, knowledge management has received more attention from news media and Korean government.

However, I believe that transparency and openness are still problematic and there is a long way to go in addressing the problem.  Transparency and openness eliminate inefficiency stemming from information asymmetry among actors in making decisions.  Asymmetry of information generates moral hazard and adverse selection which causes misallocation of resources and economic inefficiency. These are common problems in countries where industrial policies are practiced. This is an example of influence cost that more capable chaebols may not be selected for the projects due to influence of decision makers although the role of government industrial policy is diminishing lately.

Chinese Social Sciences Today: Some believe that the chaebols are a hindrance to national progress and President Lee Myung-Bak believes Korea’s future relies on the prosperity of small and medium-sized companies, what do you think?

Park: Small and medium-sized enterprises (SMEs) are significant portions of the Korean economy. As of 2009, Korea’s SMEs accounted for 99.9 percent of all business establishments and they 87.7 percent of jobs in Korea. The competitiveness of the Korean economy depends on the strong and healthy SMEs. Chaebols use SMEs as their subcontractors and SMEs provide supplies to chaebols.
The Lee Myung-bak government changed the policy direction after the 2010 local election.  Lee’s government was losing the support of young people because of his high unemployment for young people. Unemployment rate is about 10 percent among under-30s compared with 3 percent among over-30s. His government was also losing the campaign of the “fair society” that he had advocated as the president of Korea. Educated youth unemployment is a thorny issue for Korean government. The problem is a mismatch of education level and low paying jobs in SMEs. College graduates may not have skill sets for jobs in SMEs. SME’s wages are low due to their low productivity and highly educated college graduates are not taking those low paying jobs.  These jobs are filled with workers from other countries. Nevertheless, President Lee wants to revive the fair society campaign by advocating shared growth, proposing “shared growth” policy which includes key reforms such as a shared growth index, designating SMEs-suitable business areas, and introducing a profit sharing system.  These reforms can be evaluated and government can take remedial steps if goals for these reforms are not met. 

However, the SME-only business system was abolished a few years ago. The government’s financial loans and public investments for 2012 are over 1 trillion won (about $10 billion). The Lee’s government needs to direct its policy to increase productivity of SMEs so that they can pay higher wages to their employees. His government should support technology and management improvement as well as better access to financial resources.  Government in Korea, like many other countries, supports small and medium-sized enterprises, but its policies were not effective in solving problems. All policies accompany adverse consequences and government needs to develop an institution to remedy them as they arise. Problems in moral hazards and adverse selections are ubiquitous in government policies.  Government needs to address them, making policies to enhance efficiency and the competitiveness of Korean economy.

Healthy SMEs are important because they produce goods and services for domestic consumption and create more jobs. They also supply parts to large chaebols in Korea. Large chaebols may improve their short-term profits by paying lower prices for parts received from SMEs; however, they can lose the competitive edge in the long-run as SMEs cannot afford to invest in new technologies and innovation. Chaebols and SMEs are interdependent and they need to prosper together.  Small companies can also grow to become chaebols. It is a good policy from a fair society or shared growth perspective. The question is how to design a good or efficient policy. Government can learn from best practices in the world in today’s knowledge economy, finding out what works and what does not work from its own experiences and knowledge available in the world so as not to repeat mistakes.

Chinese Social Sciences Today: I’ve learned that some proposed to have economic democratization and chaebol reform, proposing to tackle the shareholding structures of South Korea’s chaebols so that their founding families may loosen their grip on the chaebols, how do you view this and what effect will that have on chaebols and Korean economy?

Park: Wow, these are complex issues and there may not be a simple answer.  I will try to make it as simple as possible. Chaebols normally have a pyramid shareholding structure that help control many business units by a single family. A typical chaebol consists of 40-50 business units. The ownership is concentrated in one family. One of the drawbacks of the market economy or capitalism is the concentration of capital ownership which may contribute to income inequality in the economy.  Extreme income inequality can lead to social instability and even lower economic growth. Therefore, fair (not equal) income distribution is one of the main subjects of economics.  This very issue is being actively discussed in the U.S. this year because the Congressional Budget Office study published this year shows that income inequality grew significantly between 1979 and 2007.  Concentration of physical capital and human capital aggravates the income distribution problem and the wealthy individuals and chaebol owners may exercise undue influence in political and economic spheres. It is natural to make efforts to alleviate this problem. 
The question is how to accomplish the goal of reducing income inequality. Economic democratization debated in the Korean presidential election this year is probing answers to this important issue which is also connected to corporate governance. Cheabols’ owners are also managers in Korea and issues in this type of management structure include high debt, expropriation of dispersed minority shareholders, the lack of opportunities for talented managers to reach to the top, hidden information, cross-subsidy, transfer pricing and self-dealing. Remedies are legal protection of minority shareholders, establishment of a system to recruit managerial talents, better monitoring of transfer pricing and cross-subsidy, and improvement of transparency.  Broad ownership of corporate stocks (democratization of corporate ownership) will be beneficial for both alleviating income inequality and increasing loyalty to chaebols.  It can be accomplished by increasing retirement funds for the poor and low income families. These funds may include shares of all chaebols.

I have mixed feelings on diluting ownership control. As we limit owners’ control we may increase agency costs in chaebols which may reduce the global competitiveness of chaebols and economic growth.  Additional costs may include losing the managers’ ability to make timely decisions and the agility of the chaebol. Therefore, economic democratization requires striking a good balance between owners’ interests in timely control and the public’s interests of fair income distribution. Proper assignment of corporate ownership and decision rights are very important for a nation’s economic growth.

Chinese Social Sciences Today: How do you view punishments for violations of the law by chaebol heads? In some cases they are just dismissed from charges because their crime is deemed as “not serious enough” or even because they are too important to the economy, what do you think of it? What changes or reforms should be made to address this?

Park: Once laws and regulations are in the book, violators should be punished to the extent of the law and regulation. If we apply them selectively, the society loses its legitimacy and losing people’s belief in fairness results in grave consequences and shaky ground for the very existence of the society.  Most crimes occur during the inter-generational changes in ownership and management. However, I believe that imposing heavy burdens on inter-generational changes from founders or owners of chaebols to next generations needs to be examined carefully. Chaebols go through a difficult time and even commit crimes during the changes in inter- generation of ownership and management. Korean government should avoid the high costs because prosperous chabols serve the interests of both chaebols and employees (people). Prosperous chaebols contribute to economic growth and increase employment in Korea.  Samsung is known for its high wages.

Currently, owners of chaebols try to give the inheritance of the chaebols to their children at almost all costs.  There may be causal links between law and chaebol owners’ attitudes.  I am not sure that imposing such high costs are worth the efforts at this time. I would like to see the costs reduced so that the chairman/manager can focus his/her all-out efforts on chaebols’ strategies for developing new products and services. Reforms should be directed towards striking balances between maintaining ownership right and productive use of managerial talents in chaebols.

Chinese Social Sciences Today: Like you have said, chaebols have both advantages and disadvantages, so how do you see the future of the chaebol?

Park: Business organizations are organized to produce goods and services and they have to produce goods and services that consumers want at lower costs than their competitors. The form or type of organization is very important in providing competitive advantage. The chaebol is a form of organization and it is a conglomerate. The conglomerate form of organization is more prevalent in Asia. Of course there are conglomerates in the U.S. and in other countries. General Electric (GE) is one of the well-known conglomerates in the U.S. The conglomerate is a puzzle for economists because no competitive advantages in found in the conglomerate form of organization; however, this form of organization exists in the real world and performs relatively well.

As I have stated before, chaebols have advantages and shortcomings. Corporations change the form of organization as they face problems. For example, GM’s multidivisional form of organization solved GM’s 1920 crisis of overstocked inventory. Scholars argue that this change was economizing transaction cost. I have proposed an integrative framework for theories and business practices, arguing that the economic organization is to economize transaction cost, agency cost etc. Korean chaebols need to adapt to changes in the economic environment.  They can emerge as strong organizations if they take advantage of their strengths and eliminate shortcomings. Korean chaebols were faced with the economic crisis in 1997 along with other Asian countries such as Malaysia, Indonesia and Thailand. Korean chaebols lowered debts, improved and created new competency by increasing investment in R&D, and increased globalization. They became more agile and nimble because managers/owners of chaebols could make a timely decision and adapt quickly to changes in economic environment.  Most Korean chaebols prosper now because they produce goods and services that consumers want at lower costs than their competitors. All living things engage in solving problems day and night. Korean chaebols are equipped to solve the problems they face and are likely to do well in the foreseeable future although maintaining and creating new technologies will continue to be the challenging tasks for Korean chaebols because the global economic environment is changing rapidly and it is difficult to predict the future development.

 

Hong Y Park, Professor of Economics at Saginaw Valley State University.  His current research interests include theories of the firm, strategies and firm performance, dynamic capabilities of the firm, business practices and mechanism design as well as knowledge and competence creation, and corporate competiveness.  He has published many articles in his field and won many awards.  On January 14, 2011, he was recognized as the Kyung Hee person of the year by   Kyung Hee Alumni Association for his scholarly work and leadership in Korea-America Economic Association.