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Promotion of Small Business Development in South Korea

Sakura Institute of Research, Inc.
Hidehiko Mukoyama

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- In the Context of Chaebol Restructuring -

More than a year has elapsed since South Korea agreed to accept financial assistance from the International Monetary Fund (IMF). The government of President Kim Dae-Jung, which came to power in February 1998, tackled the task of reforming the economic structure of South Korea with assistance from the IMF. Major thrusts of the reform were directed toward changing the chaebol-dominated structure of its economy. It is true that chaebol (conglomerates) had played a leading role in generating a rapid and sustained economic growth, but the chaebol-dominated economic structure which had come about in the process had given rise to various problems. They include chaebol's dangerously high leverage which they had incurred to finance their overstretched operations, a fragile financial system, a close relationship between the government and chaebol, and laggard development of small businesses.

This article discusses the effort the South Korean government has been making to develop small businesses as it relates to the chaebol-dominated economic structure. In section I, we review the role played by small businesses, and the position they occupy, in the economy of South Korea. In section II, we analyze why small businesses in South Korea have failed to develop sufficiently, in light of the problems raised by the chaebol-dominated economic structure. In section III, we examine the policy measures the South Korean government has taken for the promotion of development of small businesses, and discuss the results it has achieved and problems it faces. Lastly, in section IV, we try to divine the direction toward which the South Korean economy is heading, in light of the latest moves made by chaebol for restructuring their operations and new developments occurring in the country's small business promotion policies.

I. The Role of Small Businesses in the South Korean Economy

The role played by small businesses in the economy of South Korea has changed in step with the level of its industrialization and economic development. Until the first half of the 1960s, the industry groups in which small businesses carried most weight were food, textiles and apparel, and lumber and furniture. South Korea started export-oriented industrialization in the mid-1960s, and since then, the relative importance of the industries such as textile and apparel, plastic products, and metal and machinery had increased, while that of the traditional industries such as food, furniture, briquette, and Korean paper had declined.

This was a period in which the scale of corporate operations had expanded, and big companies had taken on greater importance in the economy by dint of increases in their exports. In the 1970s, the government had encouraged in earnest the development of the heavy and chemical industry (including automobile and iron and steel industries), and the number of small businesses belonging to metal fabricating and assembling and machinery industries, which supported the heavy and chemical industry, had increased (Fig. 1). As the years rolled on into the 1980s, the government had sought to change the industrial structure into one which was capable of absorbing the impact generated by rising wages and a stronger currency. In the process, the existing small businesses had sought to shift their business to new ones, while the government had started extending assistance to venture businesses, paving the way for the birth of technology-intensive small businesses.

Under the Small and Medium Industry Basic Law of South Korea, small business is defined as one which employs less than 300 workers and has total assets worth less than 80 billion won. Actually, however, its definition varies from one industry group to another, to reflect the situation of respective industry. One measure used for the definition is the number of workers employed. In the case of the construction industry, a construction company employing less than 200 workers is considered as a small business, while in the case of commerce and other service industries, one employing less than 20 workers is considered as a small business.

Another measure is the value of total assets. Steel mills and automotive parts makers with total assets worth 30 billion won or less, paper product manufacturers, printing and publishing houses, and plastic-products makers with total assets worth 20 billion won or less, and makers of textiles, apparel, leather-goods, or toys with total assets worth 12 billion won or less are considered as small businesses.

As of 1996, there were approximately 2.64 million small business establishments, accounting for 99.5% of the total number of business establishments (including big companies) that had existed in South Korea. As a group, small businesses employed approximately 9.1 million workers, or 78.5% of the nation's total work force. In terms of manufacturing, there were approximately 96,000 small business establishments. This accounted for 99.1% of the total establishments, and manufacturers of machinery and equipment, metal products, textiles and apparel, food, and rubber and plastic products alone accounted for 55.2% of the total.

The number of workers employed by small businesses employing five or more workers accounted for 69.2% of the total number of workers employed by the manufacturing industry. And these small businesses accounted for 47.2% of the total value-added by the manufacturing industry in 1996. As this represents a 10 point increase from 37.6% registered in 1985, it serves to underline the growing importance taken on by small businesses in the nation's manufacturing industry.

On the export front, small businesses accounted for 41.8% of the nation's total exports in 1996. Although this is not as high as that of Taiwan (49.8% in 1995), this serves to illustrate the significance of the contribution small businesses have been making to the exports of South Korea. In terms of industry groups, electronic goods had the largest share (29.0%) of exports, and they were followed by textiles (23.8%), machinery and transport equipment (15.8%), plastic and leather goods (6.9%), steel and other metal products (6.2%), and other goods (18.3%). In 1990, the share of textile and apparel stood at 34.4%, electronic goods 16.1%, consumer goods 14.5%, and machinery and transport equipment 7.7%. These percentages suggest that the export mix of South Korea has become sophisticated significantly since the turn of the decade.

II. Problems Confronting Small Businesses in South Korea

1. Characteristics of the Problems

The problems confronting small businesses in South Korea in general may be summed up as follows: (1) they are thinly layered,(1) (2) growth of those capable of producing highly sophisticated parts are inadequate, and (3) the foundation of technical training and technology development are weak. The first problem is evident from the number of establishments. The number of small business establishments (manufacturing) per 1,000 persons of population is too small in South Korea (a mere 1.7 establishments) compared with Taiwan (7.4) and Japan (3.3). The number of small business establishments employing 20-99 workers is far smaller than those employing less than 20 workers in South Korea when compared with Japan and the United States (Fig. 2). While the number of small business establishments employing less than 20 workers accounts for 85% of the total establishments and those employing 20-99 workers accounts for 12.5% in Japan, they account for 89.3% and 9.1%, respectively, in South Korea.

These figures show that the percentage of smaller businesses employing less than 20 workers is relatively higher in South Korea than in Japan. From these figures, it may be speculated that South Korea has an inadequate number of parts-producing companies operating on a scale larger than a certain size. This speculation is borne out by the well known fact that South Korea has to import key parts from Japan, and run, as a result, a trade deficit with Japan, due in part to the laggard development of its domestic parts-producing industry.

The laggard development of small businesses in South Korea is blamed on the policy followed by its successive governments. In their zeal to rush industrialization of the economy, the governments lavished assistance on chaebol, with the aim of making them an engine of its economic growth. As a result, they have built up an economic structure dominated by chaebol to the detriment of development of small businesses. Their oligopolistic control of the market and the concentration of economic power in their hands point to their dominant position in the economy. For instance, annual sales of the top ten chaebol accounted for 58.8% of the nominal GDP of South Korea in 1991, and this compares with 23.2% which the top ten business groups in Taiwan accounted for in 1990.

When viewed from the perspectives of small businesses, problems posed by the chaebol-dominated economic structure include: (1) as chaebol-affiliated companies have entered all conceivable industries, they are squeezing the sales and profits of independent small businesses (the concentration of business), (2) talented people are attracted to chaebol-affiliated companies (the concentration of talents), and (3) funds are preferentially allocated to chaebol-affiliated companies (the concentration of funds).

From the foregoing, it is obvious that the development of small businesses in South Korea cannot be promoted independently from the restructuring of chaebol. Herein lies the peculiarity of the problems confronting small businesses in South Korea.

2. Problems Inherent in a Chaebol-dominated Economic Structure

In the following pages, we would like to examine in detail how the chaebol-dominated economic structure had impeded the development of small businesses.

(1) Chaebol's Octopod-style Management

One of the characteristics of the business strategy followed by chaebol is that they make inroads in every conceivable industry in a manner suggestive of an octopus, which has many tentacles. Generally, companies diversify their business for the purpose of attaining "economies of scope." In other words, they venture into areas of business related to their core business by utilizing the managerial resources they have accumulated over the years. However, the approach taken by chaebol was different from those of ordinary companies.

The chaebol, which have played a leadership role in propelling the economy of South Korea since the 1970s, pressed ahead with a diversification strategy in step with the economic development program which its government had launched in 1962. For example, Samsung Group, a chaebol which had been built around the trading company Samsung Corporation, which was founded in 1938, advanced to sugar refining, woolen textile manufacturing, life insurance, and construction in the 1950s, and then to mass media, food processing, engineering, synthetic fiber, home appliance, petrochemicals, and other industries in the 1960s and 1970s. The group founded Samsung Electronics in 1969 soon after the passage of an Electronic Industry Development Law. Business groups, such as Samsung and Hyundai, pushed their way into almost all of the manufacturing industries and into non-manufacturing industries such as trading, distribution, financial services, and mass media, and have literally become an all-embracing chaebol.

Some argue that in addition to taking advantage of the government's economic development program, diversification of their business was designed to spread their risks (Hattori and Sato [1996]). It is also thought that chaebol sought to cut transaction costs by incorporating full lines of business within their group by creating subsidiaries and affiliates or by acquiring well-performing small businesses.

In short, chaebol's octopod-style management has certain merits, such as preferencial treatment available under the government's economic development program, the spreading of risks, and cost reduction. On the other hand, such business strategy also carried negative aspects: (1) the absence of core business for a chaebol as a whole, (2) discouragement of the formation of a market transcending chaebol, and (3) hindrance to the development of small businesses. These problems have surfaced little by little in the course of changes that have occurred in the environment surrounding the economy of South Korea.

(2) Dual Structure of the Financial System

The financial system of South Korea has long been under the control of the government, and it was known as "the government-controlled financial system." Pursuant to a Temporary Measures Law Concerning Banking Institutions, private banks were nationalized in 1961. Since then, commercial banks have performed the role as a policy tool for promoting economic development plans of the government.

Policy finance includes lending to specifically selected industries, export credits, and the National Investment Fund to finance the development of the heavy and chemical industry.(2) Policy finance plays an important role in South Korea. According to a report released by the World Bank in 1993, policy finance made by the South Korean government during the years 1973-1981 accounted for about 60% of the total lending made by deposit banks. Especially, there is no doubting the fact that export credits has contributed greatly to the growth in South Korea's exports, and that concessional loans from the government to specifically selected industries has accelerated the development of these industries.

On the other hand, however, the policy finance had given rise to several problems which crowded out commercial lending. First, as organized (formal) financial institutions set their deposit rate at a low level to compensate for the loss of profit resulting from concessional loans, they could not attract enough deposits to meet the funding demand of small businesses. In South Korea, real interest rates were negative to zero in the years prior to the second half of the 1960s and in the inflation-ridden mid-1970s, and therefore, companies which were lucky enough to get bank credits made money simply by borrowing funds from the banks.

Second, industries and small businesses which were not covered by the government's industrial development program had difficulty in borrowing funds from organized financial institutions and had to rely on unorganized (informal) lenders. They charged a high interest rate, and the real interest rate on loans obtained from such lenders exceeded 30% until the early 1970s. Third, the overbearing bureaucratic interference has impeded the development of the banks' ability to screen loan applications and manage credit risks. This still remains standing in the way of liberalizing the financial markets. Fourth, as policy finance is impervious to market discipline, funds have been allocated on the basis of arbitrary judgment. And this has given rise to a close relationship among politicians, bureaucrats, and the business community.(3)

Fig. 3 sums up the foregoing. When the market mechanism works in the organized financial market, interest rates are determined at "r" where demand meets supply of funds. In South Korea where the financial markets are under government control, lending rate is set arbitrarily at a low level (r'). As a result, demand exceeded supply by as much as a-b, forcing lenders to allocate credits within that limit. Companies which could not borrow funds from formal financial institutions have no choice but to rely on informal lenders.(4) Interest rates in the unorganized financial market are determined at rh where demand meets supply, and they are far higher than those in the organized financial market.

In such a manner, a dual structure of the financial market, that is, low-rate formal lending and a high-rate informal lending, had existed for a number of years. In 1972, the government implemented the so-called 8.3 (August 3) measure, which was designed to integrate the unorganized financial market into the organized financial market by authorizing the establishment of call loan dealers and merchant banks. As the years rolled on into the 1980s, real interest rate has stabilized in the plus territory (Fig. 4), and informal lending has decreased gradually. In the 1980s, city (commercial) banks were privatized, establishment of joint-venture banks was authorized, and mutual entry of financial institutions into one another's business took place, all under the liberalization policy implemented by the government.

(3) Export-oriented Industrialization

Export-oriented industrialization also has an important bearing on problems confronting small businesses. In an effort to promote exports, the government has established export processing zones, provided export credits, and established trade promotion organizations. Particularly, export credits have played an important role in accelerating growth in the nation's export. Any company which presented an export letter of credit could receive a loan worth up to 90% of its value at a lending rate far below the normal rate (Fig. 4). Therefore, it is no exaggeration to say that this incentive has driven exporters to do everything in their power to obtain a letter of credit. It is true that this export promotion measures taken by the government had contributed greatly to the growth of South Korea's export industries, and a number of chaebol grew during this period.

However, the export-oriented industrialization policy has given rise to a couple of problems. One of them was an excessive emphasis placed on exports. As exporters could earn profits by depositing the obtained export loans in a bank, there has emerged a tendency among companies to export anything they can sell in overseas markets. This has led South Korean exporters, as Taniura [1989] pointed out, to rely increasingly on foreign-made parts and raw materials and on domestic low wages. The other problem, which was also related to the first one, was a laggard development of linkage among domestic industries that was caused by a growing inclination of small businesses toward exports, due in part to the smallness of their domestic market. The lack of linkage among domestic industries has led chaebol to develop an octopod-style management, with the aim at building a self-contained industry group.

(4) A Weak Technology Base

Under the industrialization policy which attached priority to the development of domestic companies, the South Korean government restricted foreign direct investment. As a result, in South Korea, foreign technology was introduced, acquired, and imitated by importing machinery, equipment, and plants and by reverse-engineering the imported machinery, instead of technology transfer through direct investment by foreign companies. Particularly, chaebol imported cutting-edge machinery, plants, and technology in rapid succession with funds raised on overseas markets and developed new industries one after another.

True, this approach was effective in industrializing the economy within a short period of time, but it has left problems yet to be addressed for strengthening its technology base. First, in their rush to introduce new technologies, chaebol failed to absorb and improve foreign technology and develop technology on their own as Japanese companies had done before them - with the result that chaebol lagged behind their foreign counterparts in accumulating technologies and building their own technological base. Second, as the South Korean government restricted foreign direct investment, local companies had little chance of learning technology from foreign-affiliated companies. In the case of Japan, as its assembly industry developed, big companies phased out in-house production of parts in favor of outsourcing, and in the process, the parts-producing industry has come into its own as a self-standing industry.

The key factor which has made this possible was technology transfer from big companies to small businesses. In the case of South Korea, such transfer of technology took place only on a limited scale. This was largely because (1) chaebol themselves had inadequate technological accumulation, (2) the learning ability and technology level of small businesses were inadequate, and (3) the business linkage between big companies and small businesses was weak.

In addition to the factors referred to in the foregoing, South Korea's value system and business culture, which put a premium on white-collar jobs over technical skills, have had a negative impact on the growth of small businesses (Fig. 5). In South Korea, there is a tendency of deciding on the type of occupation on the basis of academic background, and this impedes the formation of cooperative relationships between engineers and line workers in manufacturing plants.(5)

III. Results of the Government's Small Business Development Policy, and Problems to be Tackled

In the following pages, we would like to review the policy measures taken by the government to deal with the constraints confronting small businesses. First, we survey the trends of policy measures taken in the years to the end of the 1980s. Then, we review the policy of creating group affiliation of small businesses aimed at developing subcontractors, and the moves made to improve fund raising by small businesses.

1. The Trends of Small Business Policy in the Years to the 1980s
The government began giving assistance to small businesses in earnest in the 1960s. In 1961, it enacted the Small-Medium Industry Adjustment Law (later amended in 1975) (Table 1) for the purpose of restricting the entry of big companies into areas of business (sanctuaries) specifically designated for small businesses.(6) It also established the Small and Medium Industry Bank in 1961 and the Citizen's National Bank in 1962, both exclusively catering to the needs of small businesses. The 1960s is a period in which South Korea started promoting the export-oriented industrilization, and the development of export-oriented small businesses was also encouraged by the adoption of the guidelines for developing export-oriented small businesses in 1963 and by enacting a Law for Industrial Parks of Export Industries in 1964. In 1966, the Small and Medium Industry Basic Law was enacted (and was amended in 1992), which has created a basic framework of policy measures to be taken for small businesses in ensuing years.

As symbolized by the "Declaration of Heavy and Chemical Industry-led Industrialization" published in 1973, the 1970s was a period in which the government had pressed ahead with a program for the development of the heavy and chemical industry. Major thrusts of the small business policy in this period were directed toward development of small businesses supporting the heavy and chemical industry in a way designed to encourage them to form group affiliation, as we will see later. In 1978, the Small and Medium Industry Promotion Law was enacted with a view to giving comprehensive assistance to small businesses, and in 1979, the Small and Medium Industry Promotion Corporation was established.

Development of the heavy and chemical industry fueled the growth of chaebol but at a price - the concentration of economic power in the hands of chaebol. Aware of the necessity to break the concentration of economic power and maintain a free and fair market, the government enacted the Monopoly Regulation and Fair Trade Act in 1980.

As the economic environment has changed in the 1980s (the proliferation of growth-induced economic distortion, rises in the exchange value of the won, and liberalization of the market), the government sought to engineer a balanced economic development and a change in the industrial structure. The government also shifted the focus of its small business policy to the development of regional industries, the strengthening of the technological support system for regional industries, assistance for business conversion, the development of venture business, and support for globalization of operations. The government enacted the Small-Medium Industry Start-up Support Law in 1986 and the Special Law of Business Stabilization and Structural Adjustment of the Small and Medium Enterprises in 1989. In addition, in the second half of the 1980s, the regulation of chaebol was tightened.

The small business policy of South Korea was thus built on two pillars: the shielding of small businesses from the domination of chaebol, and assistance to small businesses.

2. Results Achieved by Major Policy Measures, and the Problems

(1) The Group Affiliation Policy Aimed at Fostering Subcontractors

The basic purpose of the Small and Medium Enterprise Group Affiliation Promotion Law, enacted in 1975, was to form an organic linkage among domestic industries by developing the parts industry through organizing small businesses into affiliated plants of major assembling and fabricating companies. This policy was modeled on the system practiced in Japan, in which the division of labor takes place among parent companies and their subcontractors. Specific measures taken to promote the formation of group affiliation are: (1) industries which are highly dependent on subcontractors and in need of promotion are designated as those subject to the formation of a group affiliation, (2) parent companies of the designated industries select parts to be produced and work processes to be performed by their affiliated subcontractors, and (3) the parent companies stop in-house production of the parts and the work processes thus selected for outsourcing.

Since the implementation of this law, the percentage of small businesses which serve as subcontractors has increased from 19.7% in 1976 to 70% in 1990, and then decreased to about 50% in 1994. From this, it appears that the group affiliation policy has, to a certain extent, had an effect on the nation's industrial structure. However, in terms of the formation of cooperative relationships between big companies and small businesses, its positive impact was less than sufficient.

There were several reasons for this. First, when viewed from chaebol's perspectives, purchases of foreign-made parts made more economic sense unless they saw long-term benefit in cooperating for the development of domestic subcontractors. If the cost (c) of fostering subcontractors outweighs the present value of future benefits (b) obtained through fostering subcontractors (in other words, that they will be able to secure a reliable supply of parts at a lower cost), or c>b/i (i  discount rate), there is little incentive for manufacturers to actively cooperate for the development of subcontractors. If the government subsidizes part of the cost in such cases to make the future benefits outweigh the present cost, manufacturers may be persuaded to participate in the scheme.

Second, there were little incentive for small businesses to produce parts for chaebol. This was due in part to the fact that the domestic market for their products was too small to justify their commitment, and that the product quality and the cost level demanded by chaebol were too stiff to make the idea attractive to them. Besides, small businesses have been strongly committed to export-oriented production due in part to the incentives provided by the government's export promotion policy.

Third, not enough confidence has been built between big companies and small businesses. For small businesses, support of big companies in the fields of technology and marketing is of critical importance. In Japan, big parent companies have been providing subcontractors with technical guidance (production management and quality control) on the understanding that they will do business with one another on a long-term basis. Such arrangements proved to be durable, because both parties derived benefits from them. As Lim [1998] pointed out, what is essential for the development of small businesses is a cooperative relationship between big companies and small businesses formed on mutual trust, not one of control and subordination. Lately, there have appeared at long last in South Korea signs indicating that a relationship of mutual trust between big companies and small businesses has begun to take shape in the form of a quality control movement.

(2) Measures to Facilitate Fund Raising

Fund raising has been a big concern for small businesses. To help ease the fund raising difficulties facing small businesses, the government has taken the following measures.

1) Establishment of Financial Institutions Exclusively Catering to Small Businesses

With a view to implementing policy finance targeted at small businesses, the Small and Medium Industry Bank was established in 1961 and the Citizen's National Bank in 1962 (it was privatized in 1994). The Industrial Bank of Korea also has launched various lending programs for small businesses. The Industrial Bank of Korea provides long-term funds to small businesses to help them finance equipment investment, the Small and Medium Industry Bank supplies long-term and short-term funds, and the Citizen's National Bank lends money to mom-and-pop business operations. Since the second half of the 1980s, the government has devoted considerable efforts to encouraging the development of venture businesses. In line with this policy, the Industrial Bank of Korea has increased its lending to venture businesses.

2) Compulsory Lending to Small Businesses by Private Banks

The government instituted in 1965 a rule requiring private banks to lend 30% of their new loans to small businesses, and this compulsory lending ratio was subsequently raised to 35%. In the case of the financial institutions catering to small businesses, including the Small and Medium Industry Bank and the Citizen's National Bank, and regional banks, the ratio was set at 80%.

3) Establishment of the Credit Guarantee Fund

The Credit Guarantee Fund is designed to supplement the credit system by guaranteeing repayment of loans on behalf of small businesses which do not have adequate collateral to secure their loans, and to facilitate the lending from private banks. Initially established within the Industrial Bank of Korea in 1961, the Fund was later incorporated as an independent entity in 1976. The Fund has drawn subsidies from the government and equity contribution from private banks to finance its operations. In 1984, the Fund launched the "Linked Guarantee Programme," in which it provides guarantee jointly with big companies, and the performance of this program has since been watched closely.(7) In 1986, a Law for Financial Assistance for the Development of New Technologies was enacted for the purpose of providing credit guarantees to technology developing companies, and the Technology Credit Guarantee Fund was established under this law.

4) Direct (Debt and Equity) Financing

In 1986, the Small-Medium Industry Start-up Support Law was enacted. This law is designed to provide venture businesses with comprehensive assistance in the areas of taxes, fund raising, information, and factory siting. Particularly, it encourages establishment of venture capital, and the program has produced good results as we will see later. In July 1996, the Korean Securities Dealers Automated Quotations (KOSDAQ) was established.

In addition to these measures, the government regulated city (commercial) bank lending to chaebol. With these measures, it is fair to say that fund raising by small businesses has improved considerably. However, there are problems yet to be addressed. First, as bureaucratic regulation of financial sector had continued too long, the banking institutions have failed to develop adequate capacity to screen loan applications, and they tended to fight shy of lending funds to small businesses. Their inadequacy to screen loan applications has also led to an increase in non-performing loans. Second, direct finance market is not adequately developed, and there are no system to supply funds stably according to the diversified fund demand of small businesses. Third, an increase in lending to small business means that additional policy finance is implemented in order to deal with problems caused by other policy finance, and thus policy finance has come to take on excessive weight in the nation's business financing.

On top of these problems, maturities of notes have tended to lengthen, anda large number of small businesses are experiencing difficulties in collecting bills, raising the necessity to tighten regulatory control by the supervisory authorities over unfair trading.

(3) Tightening Regulation of Concentration of Economic Power

The share of the 30 largest chaebol in the nation's manufacturers' shipments has increased from 32% in 1977 to 40.3% in 1984 (Fig. 6). As the increase in their share indicates, economic power is largely concentrated in the hands of chaebol in South Korea, and a chaebol-dominated economic structure has been created. With a view, therefore, to restricting the excess concentration of economic power, the government enacted the Monopoly Regulation and Fair Trade Act in 1980. In 1984, it enacted the Fair Subcontracting Act to tighten controls of unfair trading done by parent companies, such as delayed payment for, or beating down the prices of, the goods delivered by small businesses, or refusal to take delivery of goods from small businesses. Since 1984, the government has restricted lending to chaebol, and amended the Monopoly Regulation and Free Trade Act in 1986 to strengthen controls over chaebol.

Due in part to such measures, the share of the 30 largest chaebol in the nation's manufacturers' shipments has been declining since 1984. The Monopoly Regulation and Free Trade Act has since been amended in 1990, 1992, and 1994 to strengthen restrictions on the cross debt guarantee among member companies of chaebol, and on the ceiling for the maximum equity contribution to the subsidiaries and affiliates within the same group.

3. Small Business Policy in the 1990s

Economic policies adopted in South Korea in and after 1990 are geared to joining the ranks of developed countries in the 21st century. President Kim Young-Sam, who took office in February 1993, adopted a Five-Year Financial Reform Program which proposed, among other things, a wholesale liberalization of interest rates, foreign exchange, and capital transaction - all with a view to gaining entry into the Organization for Economic Cooperation and Development (OECD).

The basic goal of the Seventh Five Year Plan for a New Economy, which was announced in July 1993, was to create a market system on the principle of fair competition by establishing a market-oriented economic order based on freedom of choice, competition, and openness, and by consolidating the fundamentals of the economy in ways to enable individuals to give full play to their ingenuity. To accomplish this, the government has worked out a basic strategy with a focus on strengthening the competitiveness of the industry, on attaining a proper social balance and a balanced economic growth, on promoting an open economy and its globalization, and on building a base for a unification of North and South.

The plan for strengthening the competitiveness of its industry was built on four pillars: (1) a reform of the human resources development system in ways geared to meet the requirements of an industrial society, (2) the promotion of technology development and computerization, (3) the strengthening of social overhead capital and the improvement of efficiency of the transport system, and (4) the strengthening of competitiveness of companies and the improvement of efficiency of the industrial structure. By way of concrete policy measures to strengthen the competitiveness of companies and improve the efficiency of the industrial structure, the government included in the plan some measures restricting the concentration of share ownership in the hands of a few big companies, strengthening cooperative relationships between big companies and small businesses, facilitating adjustments of industrial structure, and improving corporate financial structure.

The small business policy also was tailored to meet the requirements of the five-year plan. Under this plan, changes have occurred in the view toward small businesses, and the view positioning small businesses as a potential player in international competition came to the fore. The priority of government policies has shifted to strengthening the competitiveness of South Korean companies in an open market, and the government has tackled the task of encouraging the development of information technology and globalization of its economy. Moreover, as policy finance is being phased out, it announced a policy for expanding the credit supply for small businesses.

A new development that has emerged in recent years is the implementation of policy measures on the model of those implemented in the United States.(8) They include an innovation and research program for small businesses and assistance to female entrepreneurs. In the past, South Korea had formulated some of its policies on the model of those of Japan, and this marks achange in its policy thinking.

In 1996, the Small-Medium Industry Promotion Bureau, which had been under to the Ministry of Trade and Industry, was separated and became an independent entity under the name of the Small and Medium Business Administration. Under its Administrator, the Administration established the Planning and Management Office, the Small and Medium Business Policy Bureau, the Management Assistance Bureau, the Venture Business Bureau, the Technology Promotion Bureau, and the Marketing Assistance Bureau. In addition, the Agency established regional offices at 11 locations to promote the development of local small businesses in cooperation with regional small business support organizations.

IV. Latest Developments in Chaebol Restructuring Movement and Small Business Policy

1. Chaebol Restructuring on the move

A slowdown in exports, which was induced by a weaker Japanese yen since mid-1995, had squeezed the earnings of financially fragile chaebol, and some of the middling chaebol such as Kia and Hanbo had gone bunkrupt. And coming as they did at such a critical juncture, the Asian currency crisis, which was triggered by a sharp fall in the value of Thai baht and a financial turmoil in Japan, had touched off an outflow of foreign funds, causing a steep fall in the won and stock prices in South Korea in the second half of 1997. To head off a financial crisis, the South Korean government asked the IMF for financial assistance in November 1997. Since taking office in February 1998, the Kim Dae-Jung administration had strongly urged chaebol to divest their subsidiaries and affiliates and improve their financial positions. However, as they dragged their feet making up their mind, the government took the initiative in reforming chaebol.

On June 18, 1998, the government announced the names of 55 companies, including chaebol-affiliated companies, as candidates for liquidation. They included Hyundai Livart (a furniture maker) and Hyundai Construction Equipment Service of the Hyundai Group, Hanil Electric Wire of the Samsung Group, LG Electro-Components of the LG Group, and Orion Electric Components of the Daewoo Group. Under growing government pressure, the Federation of Korean Industries (the Korean equivalent of Japan's Federation of Economic Organizations) announced on September 3 a plan voluntarily worked out by chaebol for reorganizing chaebol-affiliated companies ranging over seven industry groups. They included a merger between Hyundai Electronics Industries and LG Semicon, and consolidation of Hyundai Petrochemical and Samsung General Chemicals.

At a meeting held on December 7, President Kim Dae-Jung and the Chairmen of five largest chaebol finally agreed to plans for restructuring their operations. They agreed to (1) reduce their affiliated companies and concentrate their managerial resources in selected core businesses (Table 2), (2) promote exchange of businesses between chaebol, (3) discontinue the practice of the cross debt guarantee among companies affiliated with one and the same chaebol by March 2000, and (4) prepare consolidated financial statements starting in FY1999.

On the following day of the final agreement reached with President Kim Dae-Jung (December 8), the Daewoo Group made public a plan to spin off or consolidate 31 out of its 41 affiliated companies. The ten affiliates remaining under its fold are Daewoo Corporation (trading and construction), Kyungnam Enterprise, Daewoo Motor, Daewoo Motor Sales (automobile), Daewoo Precision, Daewoo Heavy Industries, Daewoo Securities, Daewoo Installment Financing, Daewoo Development (finance and service), and Orion Electric (electronics). Ssangyong Motor, a maker of commercial vehicles, is expected to be taken over by Daewoo Motor.

2. Evaluation of Chaebol Restructuring

As restructuring of chaebol is in progress, it is difficult to make a fair evaluation at this point. However, the following may be pointed out on the basis of what has been made clear so far. One development worth noting is the swap of business between chaebol. Of particular significance was that Samsung, which had just entered the automobile industry in 1998, had agreed to give up its automobile division.(9) The other development worth noting is that chaebol agreed to allow their parts-producing subsidiaries to be restructured. As a result, parts-producing companies will be spun off as independent entities, and they are expected to form a market free from domination of group affiliation. It is hoped that growth of such market would be a definite plus for small businesses.

On the other hand, several problems remain. First, with the exception of Daewoo, efforts made by chaebol to scale back their involvement in various industries are not enough. Chaebol such as Hyundai, Samsung, and LG were supposed to shed more than 30 subsidiaries each. However, the number of subsidiaries these chaebol had divested as late as April 1, 1999 fell far short of the target they committed to. These figures suggest that the restructuring moves of the five largest chaebol have been slow. Even more important, interlocking share ownership among subsidiaries of one and the same chaebol has increased, in order to guard against hostile takeover by foreign companies.

This has happened because, concurrently with the deregulation of foreign shareholding in South Korean companies, the government had authorized subsidiaries of chaebol to take an equity interest in others belonging to the same chaebol with no limit, as long as such investment is not intended to create an interlocking share ownership between them. Furthermore, all of the five largest chaebol have selected their financial-service business as a key division, but it is doubtful that they can grow into internationally competitive industry. Second, the restructuring of chaebol was launched by government initiative, and not necessarily under the pressure of market force.

In this sense, it is desirable to put the restructured operations to the test of the market at their early stage, if only to improve their competitiveness. Third, focusing down of chaebol's core businesses through a scaledown of their operations and business swaps could strengthen the oligopoly of industries by a few chaebol. In order to eliminate negative effects of oligopolistic control of the market, it is necessary to allow the market mechanism to work, by further deregulating the market and by encouraging the entry of new non-chaebol-affiliated participants.

3. Small Business Assistance after the Currency Crisis

The currency crisis had hit small businesses in South Korea especially hard. Chief influence of the currency crisis were restricted lending by private financial institutions and depressed sales caused by a stagnation of the domestic and international market. The number of small businesses which had gone bankrupt during the first eight months of 1998 increased by about 65% over the same period of the previous year, to about 19,000 companies. Concerned about the seriousness of the situation, the government has implemented an emergency stimulus package for small businesses.

By way of financial assistance, the government expanded the amount of funds provided under the guarantee of the Credit Guarantee Fund. The government appropriated 26 trillion won in the first half of 1998, and an additional 18 trillion won in the second half, to the Credit Guarantee Fund. In addition, the government plans to channel US$1 billion out of the loan from the World Bank to the Credit Guarantee Fund and other organizations. In the past, the Small and Medium Industry Promotion Corporation had been providing only indirect assistance in small businesses' fund raising. At present, it is making loans directly to them, particularly to those which cannot obtain loans from private financial institutions.

The prime rate charged by the Corporation is about 10.5% compared with 13-14% charged by private banks. The Corporation asks borrowers to secure 50% of the loans by collateral and cover 30% by a guarantee, but requires no collateral or guarantee for the remaining 20%. (These figures are based on the data gathered through interviews the writer conducted in November 1998.)

Even more serious than the financing difficulty for small businesses was a sharp decrease in sales. The decrease was blamed on a sharp contraction in domestic demand and a slowdown in exports to Japan and Southeast Asian countries, whose economies are in recession. The government implemented assistance measures for small businesses such as increasing its purchases from small businesses, supporting their export, and providing credit guarantees to exporters. In concert with the Korea Trade-Investment Promotion Corporation (KOTRA), the Small and Medium Industry Promotion Corporation is helping small businesses develop overseas markets for their products. Under the arrangement, KOTRA provides information concerning overseas markets and takes steps to cultivate the markets for small businesses, while the Corporation, in cooperation with KOTRA, assists them in developing new products. So far, the Corporation has selected about 1,000 companies which have a potential for expanding exports.

4. Long- and Medium-term Assistance to Small Business

Policy measures the government has been taking from the long- and medium-term standpoints include those designed to (1) improve the structure of small businesses, (2) strengthen the financial positions of existing small businesses, (3) assist in their effort to computerize their management, (4) promote the development of venture businesses, (5) strengthen the competitiveness of small businesses through technological innovations, and (6) improve their international competitiveness. In the following, we would like to briefly review some of these measures.

The first measure is the provision of assistance to venture business. It traces its origin to the Small-Medium Industry Start-up Support Law enacted in 1986. Under this law, the government has been extending comprehensive assistance to small businesses in the areas of taxes, fund raising, information, and factory siting, with a view to building a balanced industrial structure, strengthening their international competitiveness, and promoting the development of technology. The government is especially encouraging the establishment of venture capitals.

Due to such encouragement, the number of venture capitals has increased from 48 in 1995 to 53 in 1996, to 61 in 1997, and to 71 at the end of 1998. Individual investors hold a majority share in 15 out of 71 venture capitals. The Industrial Bank of Korea has been stepping up its lending to technology-intensive small businesses since the turn of the decade, and providing loans on the security of technology as collateral is catching on among other general financial institutions.

The creation of a Venture Business Bureau within the Small and Medium Business Administration reflects government enthusiasm for assisting venture capitals. President Kim Dae-Jung is strongly committed to providing support to venture businesses, and his administration aims at increasing their number to 20,000 companies over the next five years. More recently, an "angel market," a forum where entrepreneurs and investors get together to discuss matters of common interest, was created, and an investment evaluation system was instituted within the Small and Medium Business Administration. In addition, the government plans to turn KOSDAQ into a securities market exclusively catering to venture businesses.

The second measure concerns assistance for computerization. The government has been assisting small businesses to computerize their management to prepare themselves for the forthcoming computer age. More specifically, there is a plan to create by the year 2000 a computerized information network linking the Small Business Agency and other small business-related organizations with small businesses. Small businesses are given assistance on writing computer programs for use on the network. In addition, the Small and Medium Industry Promotion Corporation has been trying to spread electronic commerce by installing a virtual gallery on its home page to help small businesses cultivate the market for their products. It is also helping small businesses to solve the Y2K problem.

The third measure is one designed to improve technology. Measures have long been implemented to help small businesses improve their technology. More recently, the Small Business Innovation Research Program was instituted on the model of those implemented in the United States. Under this program, part of the budget for government agencies is allocated to technology development by small businesses. Also, a "technomart" was opened to facilitate the exchange of views among small businesses, research bodies, financial institutions, and universities on the commercialization of technologies developed. Other measures include the 100PPM promotion campaign for improving quality control, and a "home-doctor system" for extending technology guidance by circulating specialists.

The fourth measure is assistance for globalization. In addition to export assistance mentioned earlier, technology tie-ups and joint ventures with foreign companies have been promoted, with a view to helping small businesses improve their technology. For this purpose, the government (1) has introduced a preferential tax system for foreign investors, (2) has been promoting deregulation of the market, and (3) has established a "one-stop service system" to provide pertinent information to those which are planning to invest in South Korea. In 1994, the Korea Foreign Investment Service was established within KOTRA.

‡X. Outlook and Problems

As noted in the foregoing, the chaebol-dominated economic structure which had impeded the development of small businesses has been changing in South Korea. The prospects of chaebol restructuring still remain unclear, but if chaebol shed some more of their affiliated companies and concentrate their managerial resources in selected businesses, it is likely that (1) their business transactions with non-chaebol companies, (2) outsourcing of work by them, and (3) the number of their skilled workers or managers shifting to small businesses, will increase. If such changes occur, this will increase the opportunity for small businesses to grow, together with increasing government assistance to small business.

On the other hand, the environment surrounding small businesses could turn bleaker than before, because the protectionist policies - such as the designation of industries exclusively open for small businesses to which the entry of big companies is restricted, and the import diversification system which in effect restricts the import of Japanese goods (this system is scheduled to be abolished in June 1999) - will be phased out in coming months. Thus, small businesses also will have to improve their financial position and technology level.

Lastly, the deregulation of the market and demand for technological tie-ups will have a significant meaning to Japanese companies. Until now, import of machining centers and numerically-controlled (NC) lathes from Japan has been banned. The lifting of these bans in mid-1999 will enable Japanese machine builders to export these machines thereafter. In anticipation of the lifting of these bans, Japanese machine tool builders and robot makers have already started building their distribution networks. In this sense, the present changes taking place in South Korea will call for the rebuilding of the business strategy of Japanese companies in South Korea.

End Notes

1. Matsunaga [1996] emphasizes the role played by mom-and-pop operations which are not adequately reflected on statistics. According to Matsunaga, mom-and-pop operations are extremely broadly-distributed and have become a source of business formation.
2. The National Investment Fund raises funds by issuing bonds to banks, insurance companies, and the postal agency. For further details, see Ito [1983] and Taniura [1989].
3. In view of the rampancy of illegal lending and the close relationship among politicians, bureaucrats, and businessmen in behind the scene, it must be said that the evaluation of South Korea by the World Bank [1993] is superficial.
4. In Fig. 3, it is assumed that the supply curve of the unorganized financial market starts from r, which is the equilibrium interest rate of the organized financial market, because funds would otherwise shift to the organized financial market.
5. For further details, see Hattori [1988].
6. As of 1995, 135 industry groups were designated. However, as the market has been deregulated in ensuing years, these industry groups are being opened to other participants.
7. UNIDO [1997]
8. For details on the small business policy of the United States, see Hidehiko Mukoyama, "Small Business in the United States, Taiwan, and Japan, and Their Small Business Policy" in the Sakura Institute of Research, Pacific Business and Industries RIM, 1998 Vol.II, No.40).
9. When Samsung agreed to assign Samsung Motors to Daewoo Motor, workers of Samsung Motors staged a 70-day strike demanding the guarantee of job security. The strike was called off when the management agreed with the labor union to pay a special bonus and, for those who move to affiliated companies, to guarantee employment for two years.

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