Tuesday, November 2, 2010

The Fed Had A Shot to Get it Right By Mimicking Korea: Facing a Total Economic Collapse, KAMCO Saved Korea

Last week, this article appeared in the New York Times/Reuters Global Business Section which was suggesting that China follow Korea's path in order to increase the per capita GDP.  It was quite complimentary regarding Korea's reaction to the economic crisis of 1997-1998..  It does point out that the linkages among the different subsidiaries within a single chaebol were indeed broken, and that led to a path where a sustained economic recovery could ensue.

Here is the quote:
South Korea, though, after nearly defaulting on its debts at the end of 1997, pulled itself together and resumed its march up the value chain.
The key reason is that Seoul embarked on far-reaching market changes. In particular, the government reduced the power of the chaebol, the sprawling debt-heavy conglomerates whose links to the state created the impression that they were too big to fail.

Close, but not quite.
There is no doubt that the tangled web of the related companies of the large conglomerates was larely unwoven.  However, the conclusion that the government reduced the power of the chaebol isn't quite accurate.  There are a number of reasons that this is an inadequate description of what actually occurred.

First, and by far the most important, fact is that bad assets, whose value was only worth a few percentage points of reported book value, were cordoned off into the Korea Asset Management Corporation.  This included assets such as real estate, failed banks, and distressed companies.  Those assets were then correctly valued by the marketplace (although in the Goldstar/KEB case, this has been a very long, drawn-out process), and sold in a controlled fashion.  The analogy to KAMCO was the "good bank/bad bank" proposal that surfaced, and ultimately rejected, in the US during 2008. 

Second, the untangling of the cross-holdings of the debt issued by the related companies of the chaebol was absolutely key.  It wasn't that the influence of the chaebol was diminished per se.  It was that the financial viability of performing assets was more indentifiable by the market and that capital naturally flowed to the most desirable, and now relatively tangle-free, companies.  The best example of this was the Hyundai Group.  Perhaps more important than Hyundai Auto, which was already well-known to the world at that time, was the fact that Hyundai Heavy, the largest Korean shipbuilder had an extremely complicated financial relationship with Hyundai Group.  As a result, an investor of any sort, whether a lender or a shareholder, didn't quite know to where capital was allocated.  Once the tangled web was unwoven, then capital correctly chose the "winners" and the market let the "losers" fail.  Now, it did so with obvious governmental support at that time, but it did so nonetheless.

Third, the effect on Korean banks was that they too could report more accurately their exposure to specific Korean entities. This cannot be understated.  In the Korean language, there is a saying which is loosely translated to "money turning around makes more money."  In English we would say "you need to spend money to make money," or something like that.  The cleansing of the balance sheets of Korean banks made it possible for lending to resume, and importantly, to resume to entities without the spectre of a debt and stock cross-holding nightmare. 

Fourth, the article seems to minimize the dominance of the largest Korean chaebol.  Perhaps that is the view of a foreigner who has not spent a long time in Korea with Korean natives.  There have been, of course, gradual changes.  Nevertheless, the dominance of the largest Chaebol remains.  A viable explanation for the lack of a Korean "Steve Jobs" leader is that even if a pioneer had a vision, and a product that reflected that vision, that the business execution of that vision is made almost impossible because a chaebol would either buy that business before it grew into its own individual entity, or a chaebol would effectively crowd out the potential new competitor due to the dominant links to the retail chain, or that the visionary would thrown in the towel under the weight of potential competition and sell his/her idea too early to a large chaebol group.  Currently, a very compelling argument can be made that the underemployment of the very highly-educated Korean college graduate population is the result of lack of entrepreneurship opportunities which are effectively squealched by the chaebol.  Instead, Korean college graduates, faced with increased competition for few cherished jobs at the chaebol, instead opt for yet another degree to try to prove their worth to these dominant corporations.  Whether that is intentional or not is not the issue:  that it occurs is a fact.  That creates a viscious circle where the next student wants to obtain yet another, more advanced degree.  The result:  enormous structural underemployment. 

In short, yes, the NYT is accurate in that there have been large reforms in Korea since 1997-1998.  However, the nature of those changes, and how they supported the Korean economic revival, are slightly off the mark.  When history is written on Japan (over the past two decades), China, and the US during this period immediately following the financial crisis of 2007-2008, The Lost Seoul believes that sub-optimal growth occuring is because an opportunity was missed.  Korea seized that opportunity by cleaning its own balance sheets as much as they could have been, and creating KAMCO.  Then and only then could the improved global competitiveness of Korean products be fully recognized. 

The Lost Seoul


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