Special Report on the Koreas: The Bulldozer

THE KOREAS

The Bulldozer

Sep 25th 2008
From The Economist print edition

Enters stage right; trips head-over-heels

THE president since February, Lee Myung-bak, swept to office with a simple message: he would electrify the economy. For the past five years South Korea has averaged an annual growth rate of about 4.4% (see chart 2): below potential, most economists reckon, and anaemic by the standards of a country that had one of the world’s highest growth rates in the 1970s and 1980s.

South Korea had made extraordinary progress immediately after the devastation of the Asian financial crisis of 1997-98 that had led to a $57 billion bail-out by the International Monetary Fund—a humiliation for a country that had recently joined the OECD club of developed economies—and a brutal drop in output of 15% or so. The left-leaning government of President Kim Dae-jung turned radical, going well beyond even what the IMF demanded of it. It swiftly took over the banking system before selling much of it to foreigners: nine of the 14 commercial banks are now foreign-owned. It forced a number of indebted chaebol (the family-owned conglomerates that have long dominated the South Korean economy) into bankruptcy, and pushed others to dump loss-making businesses.

Exports quickly revived and domestic demand also surged, thanks to brief booms in housing and consumer credit. By 2003 South Korea was a favourite among international portfolio investors. Yet now the air seems to be going out of a once pumped-up model. For instance, South Korean graduates are having trouble finding decent jobs, if they can find any at all. And it is not just Koreans who feel flat. Foreigners have left the stockmarket in droves.

South Koreans argue over what is wrong. One camp blames the owners of capital, in particular the chaebol, for keeping wages low by threatening to send jobs overseas, and for suffocating the nation’s myriad small and medium-sized enterprises (SMEs). The second camp blames the unions for illegal strikes and rigid work practices. For economists, the problem is a lopsided economy that has long given priority to manufacturing exports over services and domestic demand. The country’s export sector is remarkably robust (see article), but an American-led global slowdown will emphasise this imbalance. Since the export sector is already highly productive, new sources of growth will have to come from these two underperforming areas.

In theory that should not be too hard. Productivity in the service sector is only two-thirds that in manufacturing, the largest gap in the OECD. Turnover per employee is just one-third of the American average in areas such as law and accounting. Low productivity matters, since services employ three times more people than does manufacturing, and SMEs account for nine-tenths of that employment.

Start here
The OECD lists the problems succinctly. First, industrial and tax policies have long favoured manufacturers. Second, barriers to entry into service industries remain high, with foreign investment excluded from nearly every business except finance. Much has been made of a ground-breaking free-trade agreement (FTA) signed last year between South Korea and the United States, but the deal excludes American firms from education and health care. The benefits of foreign investment in services are clear: when the South Korean banking sector was opened after the financial crisis, post-tax profits nearly trebled in the four years to 2005, and the return on assets grew by almost two-thirds. Foreigners brought in know-how and transformed banks’ risk management.

AFP

Beefing about beefLastly, low labour productivity in services is a consequence of a skewed employment structure. As in Japan, companies in South Korea tend to reward employees less on merit than on seniority, and dismissals are rare. So rather than be burdened with too many expensive older workers, companies impose a low mandatory retirement age. Employees tend to leave firms at around 50, and three-quarters of them become self-employed, mainly in services.

Economists agree about other shortcomings too. During decades of military dictatorship, growth at all costs took precedence over the interests of workers. Since then, successive democratic governments have attempted to strengthen workers’ rights. For instance, the previous president, Roh Moo-hyun, attempted to protect temporary workers by obliging companies to offer them equal rights to those enjoyed by permanent employees after two years.

The unfortunate consequence has been an increase in sackings just before the two years are up and a big rise in the number of temporary workers, who now make up one-third of the entire workforce. This hurts not only the individuals concerned but also the economy as a whole: temporary workers are denied the kind of training which in the long run boosts economic performance.

Economists also point to a vast accretion of regulations, interventions, subsidies, special taxes or special tax exemptions, loan guarantees and countless other measures distorting or ensnaring nearly every economic activity in South Korea. This is a legacy of decades when the government—central and local—was directing development and economic growth.

It affects not just business but consumers too. The experience of a former Seoul correspondent of The Economist is just one example. Recently her house of over 30 years was seized by the Seoul metropolitan government under a compulsory purchase order to make way for a development of luxury condominiums. Without being offered a choice she was allocated a new flat elsewhere, which she estimates to be worth at least a third less than her former home. To rub salt into the wound, she had to complete dozens of separate sets of forms and make 15 visits to various government offices. Little surprise, perhaps, that the property market is moribund.

With doubts about the economy’s vigour widespread, Lee Myung-bak looked to many to be a saviour. Presidential campaigns in South Korea are rambunctious affairs where political rallies include raucous singalongs and crowds perform synchronised dances. They are also highly competitive, yet Mr Lee, representing the conservative camp, swept the field of ten candidates with over 48% of the vote, beating his “progressive” opponent, Chung Dong-young, by a record 5m votes out of 24m cast. When he moved into the presidential Blue House after his February inauguration, he ended a ten-year run for the progressives.

What sort of mandate?
In business, Mr Lee, a trim-looking 66-year-old Christian, had won the approving nickname “the Bulldozer” for getting things done. Born to a poor family in Japan during the second world war, Mr Lee had risen to run the giant construction arm of Hyundai, then the country’s largest and most powerful chaebol. He promised that growth would be his priority during his five-year presidential term, whereas his predecessor, Mr Roh, had sought to rein in the country’s biggest businesses and spread prosperity from Seoul to less developed regions. Practical-minded and market-friendly, Mr Lee proposed a package of changes to the economy that would, he said, deliver annual growth of 7% and double South Koreans’ income per person over the next ten years.

The package was radical—but then Mr Lee appeared to have a popular mandate, thanks not only to his presidential victory but to elections for the National Assembly in April which the conservatives also won convincingly. The public appeared in the mood for the president’s pro-business message. Nostalgia for South Korea’s glory days was running high: one television advertisement showed Hyundai’s late founder, Chung Ju-yung, describing how in the early 1960s he had launched Korea’s shipbuilding industry, now the world’s biggest, on a rough field.

The new president proposed to sell a slew of powerful public entities, such as the Korea Land Corporation, that had resisted privatisation before; cut through swathes of regulations constraining the operation of businesses; reduce corporate taxes; encourage the family-run chaebol to go on an investment binge by lifting restrictions imposed by previous administrations; ease planning rules on land; deregulate capital markets; call for foreign direct investment; and streamline the government in a way that would make all these tasks easier yet still cut the annual budget by one-tenth. In addition, Mr Lee promised to pursue FTAs around the globe, starting with the one with the United States, which though signed has as yet been ratified by neither side. He made the system of higher education the target for a shake-up and he promoted national construction projects, including an ambitious if not self-evidently useful “Grand Canal” linking the country from north to south.

But then things started to go wrong for the Bulldozer in spectacular and unpredicted fashion. Least surprising, perhaps, was a dismal lack of unity among the conservatives following the National Assembly elections. For the presidential nomination the previous autumn, Mr Lee’s chief rival in the Grand National Party (GNP) had been Park Geun-hye, daughter of Park Chung-hee, the military dictator who had seized power in 1961 and ruled until his assassination in 1979. The contest for the nomination had been a bitter one and no one, least of all Mr Lee, had done much to deal with the rancour that persisted in the rival factions. The opposition took full advantage of the GNP’s in-fighting. The National Assembly did not convene until July and got properly down to business only in September.

All this underlines the immaturity of the country’s young democracy. With politicians more beholden to local interests than to their parties, discipline along party lines is weak and the level of policy debate is woeful. The parliament too often comes across as a circus for charlatans and third-raters. A good number of the National Assembly’s members have convictions or are under investigation for wrongdoings.

Even more damaging for Mr Lee were street protests that started in Seoul on May 2nd, just after he had returned from a visit to the United States. At the time the trip had seemed a triumphant success. Mr Lee’s administration had just signed an agreement with America to resume imports of beef that had been suspended since 2003, following a single case of mad-cow disease in Washington state. Congress had made it clear that without the resumption of beef imports the FTA between the two countries was dead. With the beef issue resolved, Mr Lee had been feted by President George Bush at Camp David. Yet the demonstrators claimed that the beef agreement was exposing Koreans to unacceptable health risks. The protests became a regular event, generally starting as a candlelit parade and ending in bloody attacks on police.

Fall from grace
The effect on Mr Lee’s administration was just short of catastrophic. The president’s stellar popularity ratings crashed to earth. He was forced to apologise publicly for failing to take South Koreans’ views into account. His first team of senior advisers in the Blue House was sent packing and his cabinet resigned en masse to allow him to make a fresh start. Calls grew for his own resignation. The beef deal was hastily renegotiated and Mr Lee’s idea for a Grand Canal was dropped.

So has Mr Lee learnt his lesson? On August 15th South Korea celebrated the 60th anniversary of its founding. In the Confucian world 60 is a revered number, signifying a human life coming full circle. Mr Lee used the occasion to relaunch his agenda, albeit with more humility. Ambitious quantities of bills are now being introduced into the National Assembly, in the hope that most of the legislation required for the proposed reforms will be passed by the end of this year. But doubts persist. The government distracted itself with a paranoid campaign to punish the television stations and internet sites that broadcast distortions and plain lies over the beef issue. It should have learnt a lesson about the importance of communication: it should be running a permanent campaign.

The deeper question has to do with the character of the president himself. Those who deal with him every day say he is remarkably resilient, and his belief in his programme is undiminished. But they also point out that he has a habit, carried over from his business days, of getting too involved with the minutiae of his reform plans, keeping staff running around endlessly to produce fresh details for him.

If he is too much of an action man to delegate to technocrats, Mr Lee also dislikes doing many of the things political leaders need to do: schmoozing with local politicians, stroking egos in the National Assembly and keeping up a dialogue with the public. No technocrat can do that for him, and if he does not soon begin to do it himself, his programme will get nowhere.