Asian Economic Review
1st Quarter 2000
The Labor Issue --- Key to Economic Reform in South Korea
Hiroshi Imai, Senior Economist

I. Rapid Economic Recovery in South Korea: Can It Be Sustained?

In late 1998, less than one year after the onslaught of the 1997 Asian currency crisis, the South Korean economy began to see glimmers of reform on the horizon. Various economic indicators bottomed out, including industrial production.

With the tailwind coming from a rising yen and rising semiconductor prices, export expansion is now underway, and consumption and public investment are on the rebound. Because of this, the real GDP growth rate in 1999 is expected to be around 10%. Given these conditions, many believe that the South Korean economy is on its way to a gradual recovery, and an optimistic outlook on the economy is widespread.

Nonetheless, it is difficult to predict whether the South Korean economy will continue its gradual recovery, especially since the two largest structural problems from which the crisis stemmed, financial sector weakness and chaebol inefficiency, still remain.

These causes of the financial crisis can be traced back to the high growth policies pursued by the united front of government, the chaebol, and financial institutions. Industrial development policies built on the foundations of high growth since the 1970s were characterized by the state (1) designating strategic industries, and (2) implementing preferential measures toward the chaebol involved in those industries, given the relative advantage of the nation's cheap labor pool. Concentrating investments of capital and low-cost labor increased the international competitiveness of South Korean goods and made it possible to achieve export-driven high growth over the long term.

On the other hand, however, the financial sector was weakening. Specifically: (1) financial institutions were obliged to provide low-interest loans to the chaebol, thus reducing their profitability; (2) financial institutions were also forced to write off large amounts of debt whenever a firm's business stagnated so as to fulfill the policy aim of avoiding corporate bankruptcy; and (3) prudential regulations by financial authorities were delayed because of extremely strong government intervention, a factor that was compounded by the underdevelopment of financial institution risk management capabilities.

In the business sector, these kinds of industrial policies caused the large enterprises to swell and resulted in inefficiencies. In 1992, in spite of the fact that large enterprises accounted for only 1.4% of all enterprises, they accounted for 52.4% of added value and employed 34.2% of the labor force.

Up until the economic crisis hit, the chaebol worked to carry out a multifaceted strategy. As a result, many chaebol expanded into highly diversified industries.

The following three factors formed the backdrop for the business diversification of the chaebol.

First, the new projects were a source of profit for the chaebol. Because profitability in existing fields had declined due to excessive competition among the chaebol, they were compelled to continue plunging into new fields to discover ways to increase their profits.

Second, to receive preferential treatment and privileges from the national government, the chaebol had to develop subsidiaries in the new strategic industries. Each chaebol moved into and competed in government-designated industries. There was a moral hazard at play, in that firms could count on government support even during temporary downturns in those industries.

Third, there was a strong tendency for the chaebol to avoid dealings with other chaebol. If a firm had to rely on another chaebol for materials or parts because its own chaebol did not have suppliers in that industry or field, the supplier would offer less favorable prices and other sales terms than it offered to firms within its own group. Because of this, firms tended to rely on other firms in their own group for supplies.

Consequently every chaebol moved into virtually every strategic industry, and as a result, they engaged in overlapping investments and carried out enormous over-investment. After factory operation rates in the manufacturing industry peaked at more than 80% from 1994-96, they fell to 64.6% in July 1998. The economic crisis revealed the over-investment that had shackled businesses.

II. Structural Reform Proceeds Slowly

Progress toward reforming the financial and business sectors to resolve the nation's two largest structural problems, financial sector weakness and chaebol inefficiency, has been slow. In the financial sector, financial institutions have been slow to improve their balance sheets, and are unable to supply the credit needed for economic development to occur in the business and household sectors.

Certainly strong government leadership and large-scale injection of public money are having on effect on the rebuilding of the financial sector, and financial institutions are writing off their existing bad debts and increasing their capital. The government is continuing to assume their bad debts, and bad debt ratios in the commercial banking sector have greatly improved.

Still, though, this does not mean that the financial institutions' bad debt problems have been completely resolved. Government estimates indicate that even in the commercial banking sector, where a mop-up of bad debt is underway, it will take an additional 25 trillion won for banks to eliminate their bad debts from their balance sheets. Further, the government is only just now beginning to sell the bad debts that it assumed from financial institutions.

What cannot be overlooked here are the high debt ratios of the chaebol. The government has raised a banner of chaebol reform aimed at reducing those ratios to 200%, and the ratio of each chaebol is rapidly decreasing. Although the original purpose of this effort was to sell assets and eliminate debt, however, what is actual happening is that debt ratios are being reduced by increased self-capitalization, such as through the exclusion of hidden assets from profit and cross-shareholding among group companies. The outstanding debts themselves, meanwhile, are not actually being reduced. The chaebol continue to maintain high levels of debt, which serves as a potential hotbed for bad debt.

The highest risk factor in South Korea today is the financial instability that would be caused by the collapse of the chaebol. Because the chaebol represent such a large share of the economy, the effects that a collapse of even one of them would have on financial institutions are unfathomable.

These fears were realized when Daewoo collapsed in July 1999. Until that time, a full-scale economic crisis had been averted by government efforts to hammer out dynamic measures to deal with the economic situation. With no guarantee that the same fate will not befall other chaebol, though, the South Korean economy is holding the spark that could ignite a wildfire of financial instability.

III. Employment Problems Block Reform

Without restructuring, chaebol debt will not be reduced. This is where the bottleneck of financial reform can be found, at the root of which lie the chronic excess capacity and over-employment of the chaebol.

Though the post-economic-crisis employment situation has seen some improvement, South Korea is not yet out of the woods. If chaebol reforms create new unemployment, it will result in major social instability and will pull the rug out from under the economic recovery efforts already in progress.

An examination of the post-crisis employment situation reveals that the effects of the economic crisis that began in November 1997 rapidly worsened until unemployment reached a high of 8.7% in February 1999. This rapid increase in the unemployment rate is explained by rapid increases in bankruptcies among small and medium-sized businesses and increased layoffs by firms trying to avoid collapse. Because small and medium-sized businesses in South Korea receive little government support and lack financial brawn, they are much less capable of withstanding conditions of recession than large firms. Many small and medium-sized businesses came to a standstill because, in addition to the economic crisis and the cooling of domestic demand, banks began restricting loans to those businesses.

Employment conditions later showed an upward trend, but unemployment was still high compared to its 2.1% level in October 1997. Also, the actual employment environment was worse than the statistics suggested for the following reasons. First, though the government's short-term policies may have temporarily increased employment, its efforts to deal with unemployment emphasized short-term employment periods of only several months, so they only had a limited effect.

Next, with the onset of the financial crisis, firms began to reduce their number of regular employees and rapidly began replacing them with part-time workers. South Korean labor statistics define a worker as someone who works more than one hour per week. Consequently, if part-time and temporary workers are included in the unemployment statistics, the actual number of unemployed workers rises. Recent employment trends show: (1) an increase in temporary and daily workers; (2) an increase in the number of employees working less than 36 hours per week and especially in those working less than 18 hours per week; and (3) an increase in laid-off workers.

In addition, there is a significant number of people who have become so distraught from losing their jobs that they fail to look for new ones. These factors all suggest that current unemployment figures do not accurately reflect actual unemployment, and that it is still too early for optimism.

Reports indicate that the top thirty chaebols account for just under 20% of employment, and there are concerns that chaebol restructuring will produce large numbers of unemployed workers. In this regard the interests of the chaebol management and the labor unions coincide, with both strongly opposing chaebol reform. Also, though the government is singing the praises of chaebol reform, it is hesitant to carry out radical dismantling that would result in massive unemployment.

Both the Federation of Korean Trade Unions (FKTU) and the Korean Confederation of Trade Unions (KCTU) have wiped the pro-government attitude off their faces and are flatly opposed to structural adjustments and chaebol reform. With circumstances as they are, some fear that labor disputes will erupt and become long drawn-out affairs. Indeed, the number of disputes, days lost, and amount of export losses were much higher from 1998 to 1999 than prior to 1997.

Employees, the majority of whom are union members, are fiercely opposed to the restructuring plans laid out by the five major chaebol, and compromises, such as delaying dismissals and drastically reducing the number of employees to be dismissed, have continued to occur in the name of employment security. For example, Daewoo Motor initially planned to cut as many as 3,000 employees, but decided to delay those dismissals until the year 2000 due to labor union opposition. Hyundai Motor likewise initially planned to cut its work force by 18%, or 8,189 workers, but after fierce labor union opposition, ended up dismissing only 277 workers.

IV. Channels for Employment Urgently Needed

To restore the health of the financial system through drastic chaebol reform, it is essential that labor issues be included in the purview of potential solutions. For the massive number of employees dismissed by the chaebol to be reabsorbed would require that: (1) small and medium-sized businesses be cultivated as a channel for that employment; and (2) the former employees of large firms be trained with new skills.

A. Cultivating Small and Medium-Sized Businesses

In South Korea, the development of small and medium-sized businesses in industries outside the strategic industries has been hindered by the continuation of chaebol-oriented development policies. First, the cultivation of small and medium-sized businesses in industrial policies has been delayed. Until now, most policies targeted chaebol companies. It has only been since the 1990s that the cultivation of small and medium-sized businesses has had a place in those policies, and even then their cultivation was promoted through the strengthening of their cooperative relationships with large firms.

There was also no dearth of industrial policies that effectively hindered the development of small and medium-sized businesses. Industrialization policies that targeted assembly and manufacturing companies that relied on overseas markets to supply their capital and intermediate goods were implemented to cultivate export industries, but these had the effect of restricting the cultivation of domestic parts manufacturers.

On the financial front, low-interest policy financing was concentrated in large chaebol companies such as export firms and heavy chemical manufacturers. As a result, most small and medium-sized businesses had no choice but to rely on high-cost sources of capital from the high-interest black market, as a result of which their financial wherewithal was depleted.

Second, the chaebol that were originally partially responsible for cultivating small and medium-sized businesses had neither the desire nor ability to do so. Because the chaebol had to be successful with their business diversification in the short term as a way of offering collateral for government support, over time they lost the surplus they needed to cultivate supporting industries and small and medium-sized businesses at home. Diversification-driven expansions into areas outside their core of expertise spurred the chaebol to import inexpensive capital and intermediate goods and parts from overseas. Under these circumstances, small and medium-sized businesses were exposed to competition from the oligopolist chaebol, and their opportunities to enter markets and to expand their market shares were greatly limited.

Now that chaebol reform has become necessary, however, it is urgent that these weak small and medium-sized businesses be nurtured so that they can absorb excess employment. The following three provisions need to be implemented in order for this to be accomplished.

First is the provision of start-up assistance. The rate of small and medium-sized start-ups in South Korea is only about 3%, quite low compared to Taiwan's 20% and America's 13-14%. For this reason, the facilitation of new start-ups requires: (1) the removal of entrance barriers through institutional provisions, such as commercial law stipulations, and through the active promotion of deregulation; (2) the introduction of preferential tax treatment for start-ups to support the independence of the entrepreneur; and (3) preferential measures such as tax reductions on investments in new ventures.

Second is the promotion of competitive policies. Small and medium-sized businesses are more likely than large firms to be subject to disadvantageous business terms and conditions. To cultivate small and medium-sized businesses, it is important for monopolies to be controlled through strict enforcement of the Anti-Monopoly Law and for the activities of small and medium-sized businesses to be buttressed.

Third is institutional support for small and medium-sized businesses. These businesses face enormous limitations on business resources-goods, labor, and capital-available to them. Thus, it is necessary to provide: (1) support for training personnel with business and technological skills; and (2) financial support.

B. Policies to Improve the Mobility of Large Firm Employees

Institutionalized over-employment at large chaebol firms is a major factor hindering the transition of employees to small and medium-sized businesses, causing the development of those businesses to stagnate, and delaying industrial restructuring.

An assessment of the success or failure of chaebol reforms requires analysis not only from the perspective of the reduction of debt, increased interactions between chaebol, and the restructuring of unprofitable sectors, but also from the perspective of mobilizing and appropriately relocating excess workers.

Mobilizing excess workers requires: (1) the abolition of overprotection of employees of large firms; and (2) the installation of a safety net for the unemployed.

The abolition of the overprotection of employees of large firms involves reviewing employment maintenance subsidies provided to firms as collateral for maintaining employment, as well as eliminating supports for employment maintenance through the implementation of work-sharing methods, such as work-hour reductions, layoffs, and position transfers.

To provide a safety net for the unemployed, the government has already expanded assistance measures by: (1) extending the period during which unemployment insurance is paid; (2) reducing the number of successive years a person has to work before they become eligible for unemployment insurance; and (3) providing low-interest loans to help the unemployed cover daily living and housing costs. It is essential that a strong safety net be offered to the unemployed, but since the unemployment period only lasts until the unemployed person finds another job, financial assistance measures should also be accompanied by policies to help people look for jobs. Thus, as will be discussed below, it is important to improve the job skills of unemployed persons.

C. Improving the Job Skills of the Unemployed and Creating a Job Placement Framework

The lack of portable job skills possessed by excess employees at large firms is creating a bottleneck in mobilizing those employees into new positions at small and medium-sized businesses.

The same is true of those who are already unemployed, and in spite of what seems to be an improved unemployment rate, mismatch between labor supply and demand is growing. Underlying this problem is that, while there has been a strong tendency toward white-collar work and away from "3D" (dirty, difficult, and dangerous) work, businesses are looking for: (1) advanced technology skills; (2) skilled production and specialized skills; and (3) improvement of the skills of the unskilled production.

To eliminate this mismatch and reposition employees requires that measures be adopted to: (1) promote the transfer of business management jobs and some production jobs at overextended large firms to small and medium-sized businesses, and provide support for start-ups; (2) strengthen the technological and skill specialization of those unemployed at the level of engineers; and (3) raise the level of skills of unemployed general workers or laborers.

First, it is important that assistance and preferential treatment measures be offered to the small and medium-sized businesses that absorb excess labor from large firms. It will also become increasingly important for firms to make efforts to improve workers' skills as a way for them to facilitate the relocation of their excess employees.

Unfortunately, the government's current skill development program focuses only on the most elementary and general skills, and many who complete the program still lack the skill qualifications needed by firms. For this reason, it is important that improving workers' skills is promoted using methods employed in the private sector, as described below.

First, a vocational training system should be set up in conjunction with U.S. community colleges and Japanese company-provided training programs. To facilitate this, public and private universities should be used as they are in the U.S., and the structure used for program development should actively contribute to the industrial arena. The system should target expected growth industries, and research should be conducted on how to upgrade the skills needed in promoting those industries. Private firms should be given incentives to participate, such as special grants when their employees take courses, or first pick of graduates.

Second, a temporary worker system should be utilized for helping the unemployed find temporary work and improve their job skills. The on-the-job-training that workers receive during temporary assignments will help upgrade and expand their skill sets, thereby helping them obtain full-time jobs in the future.

To make the most effective use of the job redistribution function of the temporary job placement industry, the government needs to actively promote liberalization policies, such as the expansion of the range of businesses that use temporary workers and extension of the duration of temporary assignments.

V. Improving Labor-Management Relations

Since the economic crisis, labor disputes that had been temporarily quieted have once again flared up. Not only has a worsening relationship between labor and management struck a direct blow on businesses, but it has also had the negative effect of reducing the confidence of foreign investors in the South Korean economy and obstructing inflows of mid- to long-range capital.

A cooperative structure of labor, management, and government should be established to smoothly implement a new series of government policies, minimizing damage from labor disputes and improving South Korea's image abroad.