It is a truly heroic tale. On a rocky, crowded, and war-torn peninsula a small group of planners pick choice industries to develop. With the necessary capital fed to just the right companies, they rocket an economy to the club of rich nations in a single generation.
But today, the alchemy that worked so well for decades in South Korea has worn out. A history of government-dictated loans has left banks with little ability to analyze risk and government officials open to graft, observers say.
The most recent example is the case of Hanbo Iron and Steel Company. South Koreans were dismayed that Hanbo was able to borrow $6 billion, about 20 times its net worth. The company went bankrupt Jan. 23, making the case for disentangling government from business.
Hanbo ran up an enormous debt by building a steel mill that uses a commercially unproven technology and reportedly funneled 40 percent of the loans to other subsidiaries. But some say the debacle reflects the swashbuckling egotism of businessmen in South Korea, who believe they can do anything and pay off any debt eventually if they can just get a loan to keep going.
Had investors thoroughly analyzed the risks, the Hanbo steel plant, which is 90 percent completed, might never have left the drawing board.
Rubber-stamping official policy
But since the 1960s, lending institutions haven't had much say. To develop the country, the government picked key industries, divided the pie of available capital, and then told banks how much to lend, to whom, and at what rates. Banks didn't do independent credit analyses. "Banks were totally under government control," says Hank Morris, an analyst at Koryo Securities in Seoul. They "were simply rubber-stamping."
"By Western standards, Korean banks aren't banks. They're just money intermediaries," says Kim Jong-seok, an economist at Hongik University here.
As the government had the power to order banks around, the financial institutes learned little about how to tell good projects from bad ones. And the bureaucrats and bank presidents who made decisions were susceptible to influence from companies that wanted the money badly enough.
Although the government no longer appoints bank presidents, it can pressure banks in other ways, Mr. Morris says. Major banks here "that are theoretically in private hands are still operating at the behest of government officials," he says.
In the mid-1980s, the economy became too big and complicated for government planners to micromanage, analysts say. Once the Hanbo scandal is taken care of, the government will have to turn its attention to reforming the financial system by letting market forces replace central management, they warn.
Ironically, a presidential commission on reforms of the financial system was launched just a couple days before Hanbo went bankrupt. But the businessmen on the panel, who simply want cheaper and more plentiful capital, haven't inspired hope for meaningful reforms.
Financial analysts say three key reforms are needed: allowing Korean businesses unrestricted international borrowing at rates cheaper than domestic ones; allowing shareholders to influence bank management and letting banks offer a wider range of financial services to stimulate competition.
Although observers agree reform is essential, policymakers are reluctant to implement it because they will lose control over policy. Bureaucrats have had a successful track record developing Korea's "tiger" economy and feel that as representatives of the government they hold the highest level of responsibility, says Gweon Sung-chull, a financial writer at the Choong-ang Ilbo, a major Seoul daily. And, if they lose the authority to direct investments, they lose perks and prestige. "If everything is freed, nobody will call them." When they lose their power, "they will lose their privilege,"he says.
Last month's labor strikes
This challenge to modernize South Korea's financial sector comes on the heels of contentious labor reform that caused massive strikes last month. Both the labor-union strikes and the Hanbo bankruptcy underline the difficulties in fixing the economy's structural problems and enhancing South Korea's competitiveness.
Unless the government fixes the new labor legislation, meant to give companies more flexibility in firing workers, workers plan to strike again next week.
In the '60s and '70s, South Korea's military dictators needed labor to develop the country. Although the government brutally suppressed the labor movement, workers were placated by lifetime employment, cheap housing loans, health-care and education subsidies, and generous bonuses.
But labor advocates say that before workers can give up the generous benefit system of companies and accept being laid off, the government needs to introduce public-welfare reforms. Korea needs cheaper housing, unemployment benefits, integrated job retraining, more universal health care, and a cheaper education system, they say.
Such a comprehensive welfare system takes time to develop, says Yoon Yong-mo at the Korea Confederation of Trade Unions. And this being an election year, it "makes it difficult for politicians to turn their attention to long-term issues."
He also asserts that the country's economic health "isn't really dependent on employers' freedom to dismiss workers." He cites high borrowing, transport and land costs, and complex regulations as more formidable obstacles to efficiency and competitiveness and adds that worker loyalty has been a key element of economic success here.