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Chapter 5

Capitalism with a Korean Face

Anyone can tell you that North Korea is communist and South Korea capitalist, but what do these words mean? Authorities in the North frequently turn a blind eye to street markets and encourage investment from prospective foreign partners seeking to make a profit out of cheap labor. And in the South, capitalism is still evolving, but has some very distinctive characteristics based both on old influences like Confucianism and the unique means of industrial development known as the chaebol system.

Park Chung-hee

During the 1950s, South Korea was “the poorest, most impossible country on this planet,” according to a long-time advisor to President Park Chung-hee, Kim Dong-jin (not his real name). The Korean War had made a third of the population homeless; orphaned children roamed the streets looking for food; GDP per capita was far below $100; and, the government was utterly dependent upon foreign aid, principally from the United States. Politically, things were no better. President Syngman Rhee presided over a regime as bloody and repressive as it was corrupt.

When student protests sent Syngman Rhee fleeing to Hawaii in 1960, South Korea engaged in a brief experiment with democracy under the government of Prime Minister Chang Myon and President Yoon Po-seon. Unfortunately, the country was in turmoil—with severe factionalism, a currency crisis, and Communist agitation—and these leaders could not hold things together. Han Seung-joo, an anti-Rhee demonstrator who dodged the bullets that killed over a hundred of his comrades and eventually went on to become a cabinet minister in the 1990s, recalls, “There was a sense that we weren’t going to make it as a country.”

In this circumstance, army general Park Chung-hee took his chance. On May 16, 1961, he seized power, and he soon started putting in place the changes that would make South Korea a wealthy country. General Park—later President Park—is the one person who undoubtedly had the greatest influence on this country, for both better and worse. He remains a divisive figure due to his autocratic rule, but credit for his contribution to the economy should never be overlooked.

General Park was no Ayn Rand–style free-marketeer. In fact, long before he came to power, he was nearly executed for being part of a Communist cell. Immediately following his takeover in 1961, he rounded up businessmen and subjected them to public humiliations, such as being forced to march through the streets carrying placards proclaiming, “I am a corrupt swine.” He was not being unreasonable: during the 1950s, entrepreneurs close to the Rhee government were able to grow quickly by purchasing assets abandoned by Japanese colonialists, such as factories, at knock-down prices. Once a firm began producing a certain product, the government would block importation of competing goods from overseas. Firms that benefited from this protectionism included Samsung—still the largest business group in Korea today.

Samsung founder Lee Byung-chul, the most successful entrepreneur of 1950s South Korea, was in Japan at the time of General Park’s coup. The new regime alleged that Lee held one-fifth of the nation’s illicitly acquired wealth, had given illegal political donations, and had evaded taxes. He was somehow persuaded to return to Korea and was immediately jailed. Yet the talented and persuasive Lee managed to make a deal with General Park, offering to “donate” most of his wealth to the state and use his influence to persuade other entrepreneurs to follow the economic plans General Park was then drawing up. This offer was accepted, and Lee was made head of the new Federation of Korean Industries, an organization that to this day represents the interests of the largest Korean firms. General Park’s objective was to pursue industrial development, in order to make the country more powerful than North Korea and dig South Korean people out of poverty. In negotiating with Lee he realized that the “corrupt swine” could be instrumental in achieving this goal if their organizational expertise could be put to work in the ways he wanted.

With that in mind, General Park offered eighteen leading entrepreneurs a deal they could not refuse: participate in his development plans or go to jail. These business leaders included the founders of companies like flour miller and cement-maker Daehan and cotton-spinner Samho, who, along with Lee Byung-chul, had been heavily fined for tax evasion and the paying of kickbacks. The fines they paid were reinvested by the government in projects that General Park had asked the chosen companies to develop. As part of the government’s first Five Year Economic Plan laying the foundations for industrial development for 1962 to 1967, the focus was set on areas like fertilizer production, cement, chemicals, oil refining, and textiles,

Later, the number of firms able to participate in the club was expanded: Kim Woo-choong, who was still in school during the Rhee era, founded Daewoo in 1967 and, perhaps owing to the fact that his father used to teach President Park, was able to join. Daewoo was originally a textile firm but also ended up making electronic goods, cars, and ships, in accordance with subsequent government economic plans. In fact, Kim entered the shipbuilding business against his will—Park forced him to do it. Daewoo Shipbuilding & Marine Engineering Ltd. now generates annual revenues of over U.S. $10 billion.

Though these were the largest firms in Korea, at the time they lacked the resources required to enter such capital-intensive industries as shipbuilding and car manufacturing. However, the government was relatively flush with infusions of cash from U.S. government loans and later from payments for participation in the Vietnam War, as well as soft loans and compensation from Japan for its depredations during the colonial period. The state could therefore fund favored firms through its national banks, at rates of interest much lower than the 25 to 30 percent interest rates offered on the open market at the time. In 1964, 40 percent of all money loaned by Korean banks was shared between just nine business groups.

Corruption still existed, owing to the close relationship between government and business. It was typical for kickbacks of up to 10 percent to be paid to high-ranking officials when loans were made. Thus Lee Hu-rak, the president’s chief of staff, was able to garner an illicit fortune of a reported U.S. $40 million. A mutually beneficial relationship between the political and economic elites developed: companies received cheap loans and were able to expand, and officials got their cut. The incentives were lined up then for firms to take on as much debt as possible, and use it to expand. Throughout the 1960s, the capital structure of a Korean manufacturing firm employing more than 200 people was on average 17.3 percent equity, and 82.7 percent debt.

Despite this, President Park himself was not personally corrupt. His strong leadership and integrity ensured that the system did not dissolve into chaos. Furthermore, he encouraged an important shift that resulted in Korean firms developing into world-beaters. During the 1950s, large Korean companies were engaged in import substitution. This is when the government blocks imports and allows domestic firms to make the blocked products (usually very inefficiently) and sell them in the local market. President Park’s shift was to instruct the companies to export as well, and thus Korean firms had to learn to compete on the international stage. High import tariffs remained, ensuring that Korean products kept their advantage at home, but the necessity to compete abroad meant that groups like Samsung and LG became highly efficient operations.

Not all could make it. Though it is true that Korea’s economic miracle was a result of partnership between the state and industry, one aspect of proper capitalism did remain: it was still possible to fail. Especially in the early days, bankruptcies were more likely than may be imagined. Gaepung, one of Korea’s five largest firms during the 1960s, had disappeared by the mid-1970s; Dongmyung, which was the world’s largest seller of plywood in the early 1970s, went under in 1980. Since the mid-1980s, though, the top ranks of the largest Korean firms have been more stable. Between 1983 and 2000, only two business groups lost their place in the top ten. This could be due to the fact that large Korean firms and the Korean economy as a whole are both more stable now; it could also be due to reduced political interference.

The sprawling conglomerates that grew under Park’s auspices became known simply as daegieop (big business), or chaebol. The word chaebol comes from the same (originally Chinese) characters that make up the Japanese word zaibatsu, which means a kind of “financial clique.” The model for the chaebol was the vertically integrated zaibatsu conglomerate from nineteenth-century Meiji Japan, only more centralized and without the ability to own banks. The state controlled the banks, allowing President Park to keep hold of the purse strings.

Lotte is probably the most ubiquitous chaebol from the perspective of the Korean consumer. Founded in Tokyo in 1948 by Shin Kyuk-ho, a Korean living in Japan, Lotte first entered Korea in 1967 with a confectionery business, before spreading out with President Park’s blessing. One can still buy a Lotte chocolate bar today. In fact, Lotte is Korea’s dominant maker of chocolate, cookies, and other snacks. But one might also purchase the chocolate in one of the many large Lotte Department Stores. Within a Lotte Department Store or Lotte Cinema, one will likely find a café named Angel-in-us or a fast food restaurant named Lotteria. Both are owned by Lotte. One may live in a Lotte apartment and protect it with Lotte insurance. One’s weekly shopping may be done at a LotteMart. Lotte Group has over sixty subsidiaries, employing over 60,000 people. It has a credit card company, too—but no bank.

The Chaebol Approach

Chaebol-style capitalism was, and to some extent still is, very different from the dictionary definition of capitalism. Not only was industry directed by the state, but the chaebol corporations were rigidly hierarchical and bureaucratic, influenced by Confucian culture. Firms were expected to treat workers as sons, and workers were expected to respond in kind by thinking of their chairmen as father figures and offering absolute loyalty. It was a paternalistic style of management reminiscent of the father-son relationship in Confucianism. Companies would give employees gifts on their birthdays and national holidays, much as a parent would do for a child. When the close family member of a worker died, the firm would also assist with funeral expenses. Leadership of chaebol was also a family concern—literally. Sons of chairmen were accelerated through the ranks, and given subsidiaries to run; the one who did the best job would eventually inherit the chairmanship of the whole group from his father. All the major chaebol today are run by descendents or in-laws of founders. In that respect, it is scarce wonder that foreign journalists often jokingly compare chaebols with North Korea, the supposedly socialist state that is now on its third generation of monarchical rule.

From the 1960s, chaebol wages were kept low and unions banned—but headcounts were higher than they would naturally have been. The corporate philosophy was of “growth together,” everyone working for the same goal of national economic development. The state supported this with poster campaigns exhorting people to work hard and hit government-set export targets. Chaebol bosses typically owned just a small percentage of their companies, with much of the rest belonging to banks or the state. Import tariffs on critical industries were kept high, in order to protect nascent domestic firms.

The economy was so dominated by these muneo kyeongyeong (“octopus businesses,” each with a battery of subsidiaries) that true competition—a cornerstone of capitalism—simply did not exist in the domestic market. Chaebol had to be competitive on an international scale, a feat they accomplished extremely well. However, if you were a Korean consumer, the only choice was usually a chaebol-made product. It was also often a reverse-engineered, intellectual property rights–busting product copied from elsewhere.

Furthermore, the power of these companies, supported by the state, meant that there was no real culture of entrepreneurship in South Korea. For a talented young person, the most attractive jobs other than in the professions of doctor or lawyer were either in the civil service or entry-level positions with the likes of Samsung or Hyundai. The possibility of having a truly self-made Korean Bill Gates was little more than zero. If one looks at the Kospi-100 index of the largest Korean firms (the equivalent of the Dow Jones or FTSE indices) even now, one still finds that the vast majority of them are chaebol. The largest conglomerate, Samsung, accounts for a full 20 percent of South Korean exports.

Less than ten non-chaebol companies in Korea have ever managed to generate annual revenues of 1 trillion won (around US $900 million). This small club is tech- and Internet-firm- heavy, containing Humax, the digital TV set top-box manufacturer; NHN, the operator of search portal naver.com; and online game-maker NCSoft. The Internet in particular is proving to be a leveler, as it provides a realm of business where, according to one young entrepreneur, “some kid with a smartphone” is not necessarily at a disadvantage relative to the chaebol.

It is still the case though that one should not compete with the chaebol. Chaebol are no longer supported financially by the government, but their sheer size due to their past advantage makes taking them on a foolish endeavor. For an ambitious entrepreneur, one’s goal should be either to sell to a chaebol, or find a blue ocean—unexplored or unexploited territory—in the way NCSoft and NHN did. If one cannot do that, then the international market offers possibilities: Humax, a company started by a group of Seoul National University engineering students following a conversation in a bar, managed to join the trillion won club by selling their products mostly overseas.

Jeong Ju-young

President Park rewarded the companies that most fulfilled his wishes—those who would build a particular road, hospital, or bridge, for example, in time and on budget. According to one insider, the two that did this best were Lee Byung-chul’s Samsung, and Hyundai, which explains at least in part why they are still the most dominant chaebols today. They were naturally more able, and their reward for this was a better head start.

Today’s business students may know plenty about Samsung, but the story of Hyundai is more revealing. The founder, Jeong Ju-young—born into rural poverty in Tongchon, Gangwon Province (in present-day North Korea)—is a model of resilience, unshakeable self-belief, and determination. His story is the story of South Korea: he started with nothing, and, relying on his capacity to overcome any problem, he took on the world—albeit with some help from Park Chung-hee, with whom he shared a strong bond over their shared belief in national development. His autobiography, available for free online in English as well as Korean, is to be recommended for anyone interested in learning more about the development of South Korea.

According to General Park’s advisor Kim Dong-jin, Jeong had a singular lack of self-doubt. The two would have meetings in which Park would detail some long, complicated project and ask, “So, can you do it?”—to which Jeong always responded, “Yes, of course I can do it.” Later, Kim Dong-jin would ask Jeong, “Do you really understand what the president wants you to do?” Jeong would say, “No, but I’m sure I can do it anyway.” That response tells you almost everything you need to know about why South Korea was able to develop so quickly after the war. One could relate it to the Buddhist capacity for overcoming and refusing to accept one’s lot; one could also relate it to the Confucian ethic of merit and constant hard work.

Kim Dong-jin tells another very illuminating story concerning Jeong. In an interview, he asked rhetorically, “Why do you think he built six, seven, and eight dry docks at his Ulsan shipyard, when other shipyards only have one or two?” The answer was not because he thought he would need them. It was that President Park believed in shipbuilding so much that he would always give Jeong money to build another dry dock, even when one was not needed. Jeong of course wanted the money for something else, so he learned how to build dry docks more cheaply and divert the remainder into the real project.

A System That Suited Its Time

This tells us plenty about Jeong’s character, but it also reveals some of the negatives of government-mandated chaebol development. Imagine if, in your country, a privileged insider was being lent government money—and then not even spending it on the intended purpose. It sounds outrageous, and the stuff that leads to scandal and resignations.

Yet Jeong was capable enough to use these resources to great effect. Today, companies bearing the name Hyundai employ hundreds of thousands of people globally. His firm and others, like Samsung, LG, and Lotte, were at least partly responsible for South Korea’s urbanization, attracting farm laborers from the countryside to the cities. Seoul had a population of around 2.4 million in 1960 and today stands as one of the world’s true megacities, home to 10 million within the bounds of the city proper and 24 million within its metropolitan area—half the population of the country. The chaebol have changed the landscape and the way people live. There are even entire chaebol cities: the city of Ulsan developed as a place for Hyundai employees to live and work, and now has a population of over a million.

The chaebol-government compact of the 1960s and 1970s suited its time. It is not a system suited to a large, modern economy, but it did, despite its faults, enable South Korea to generate enormous economic growth and dig itself out of poverty. Exports rose from $100 million in 1964 to $10 billion in 1977, and GDP per capita went from around $120 to $1,040 in the same period. The arrangement was characterized by favoritism and “lent itself to a certain amount of corruption,” in the words of Mr. Kim, but it was also a practical solution that combined the power of the state with the profit incentive and harnessed Confucianism’s ability to bring everyone in line under their chairmen, who in turn fell in line under President Park.

After Park Chung-hee

How much has changed since the 1960s and 1970s? In legal terms, virtually everything. In the 1980s, the military dictator Chun Doo-hwan set a course of economic liberalization. A group of U.S.-trained, neo-liberal advisors in the government’s Economic Planning Board (who had been virtually ignored by President Park) were given great influence over economic policy. They dropped the kind of quantitative targets set by Park’s government (for instance, the export of a certain dollar value of products) and began reducing import tariffs, and selling off stakes in banks to private investors.

Chun was not completely above intervention, though, at least for his own ends. In 1984, according to the New York Times (March 25, 1998), Cho Bong-gu, chairman of top-ten chaebol Samho, refused to bribe Chun beyond his usual U.S.$700,000, despite being advised that a golf course or hotel would be necessary. Chun retaliated by simply handing Samho over to a rival company named Daelim (with whom he had excellent relations) and confiscating Cho’s personal assets too. Cho ended up fleeing the country.

In 1997, the Asian economic crisis broke, resulting in twenty-five chaebol bankruptcies in just one year, including that of carmaker Kia (Kia was eventually taken over by Hyundai Motor). This crisis was largely the result of decades of corporate debt addiction, which began in the 1960s, finally coming to a head. Heavily indebted Daewoo, which had once been responsible for 10 percent of South Korea’s GDP, finally went under in 1999, despite the best efforts of founder Kim Woo-choong to keep it alive by cooking the books. The reform-minded Kim Dae-jung administration, which came into power in January 1998, used the opportunity to pass laws geared towards improving corporate governance, protecting minority shareholder rights, and cracking down on corruption between politicians and the chaebol.

In recent years, Korea has continued to reduce import tariffs and protectionist legal hurdles, especially for those countries with which free-trade agreements have been signed. This means that chaebol now have to compete against foreign firms in their own backyard: Apple, for instance, sold almost two million iPhones in Korea in 2010, despite Samsung Electronics making a very similar product. Thankfully for Samsung, though, its own Galaxy S phone is so competitive that it has become a worldwide success, more than making up for Apple’s encroachment on Korean soil.

Despite liberalization, the weakening of Confucian top-down thinking, and legal changes, the chaebol chairmen still have a gigantic head start over anyone else in Korea. Groups like Samsung, Hyundai, Lotte, and LG have so much money, political influence, and sway over the media that their power is still overwhelming. Their dominance of the industrial landscape is also intact: of the top fifty companies listed on the Korean Stock Exchange, only three are not chaebol (or former state-owned firms): NHN, NCSoft, and Shinhan Bank, an old bank that was reorganized by Japanese-Koreans and brought to Korea in 1982.

Chaebols often use their dominant market power to squeeze both suppliers and consumers. Small firms that sell to chaebol complain they are simply told what price to sell at. That price will inevitably be one that enables the supplier to survive, but not actually earn enough of a profit that it can expand. For shoppers, chaebol price-fixing acts as a kind of extra sales tax. Since markets for most consumer goods are dominated by a tiny handful of companies, it is very easy for collusion to occur. In January 2012, Samsung Electronics and LG Electronics were fined for a long-running operation in which they colluded to drive up the price of computers and home appliances. Unfortunately, the total fine levied—the equivalent of US$42 million—was only a fraction of their illicitly earned profit.

Perhaps one vestige of the old system is the power of chaebol chairmen to get away with almost anything. On occasions like Liberation Day (August 15), there is a tradition of presidential pardons. In a spirit of forgiveness, thousands of convictions—usually traffic offenses—are expunged. Rarely does such an occasion pass without a chaebol chairman being forgiven for bribery, tax evasion, or even violent crime. Kim Seung-yeon of Hanwha Group was convicted of abducting and beating bar workers with an iron bar (with the help of a group of henchmen) in revenge for an assault on his son. He was forgiven on Liberation Day 2008, as was Chey Tae-won of SK Group, who had been found guilty of accounting fraud worth over a billion U.S. dollars.

The justification for such pardons is always that the economy needs these men, and that it is not good for Korean businesses that are competing internationally to be living under a cloud of perceived criminality. Of course, the best way to improve the image of Korean business would be for those convicted of crimes to serve their full sentences, in order to deter further criminality. South Korea has improved immensely in recent years as an economy, a democracy, and a rule-governed society. Yet many investors around the world do not seem to be aware of this, and part of the reason is the perception of unfairness that comes from practices like the pardoning of corporate criminals simply because of who they are.

It is to be hoped that this culture changes at some point, and that more is done to encourage real entrepreneurship in Korean society. No one should wish for the weakening of the likes of Samsung Electronics—South Korea’s flagship firm and biggest export earner as a world leader in semiconductors, mobile phones, and computers—but a more advanced economy requires a freer exchange of ideas, more competition, stronger creativity, and above all, the opportunity for those with talent to build up new businesses that can take on world markets.

For the most part, the large chaebol firms today are highly efficient companies that produce products the whole world buys: Samsung televisions, Hyundai cars, and LG refrigerators. In the long run, South Korea needs to find ways to encourage a new generation of entrepreneurs to rise up and join them rather than bow before their almighty presence.