Korea and Daewoo’s Woes
Can Daewoo serve as an example for what went wrong in Korea during the 1997 crisis?
One way to answer these questions is to look at one of Korea’s most prominent companies, Daewoo. Before 1997, Daewoo was one of the key chaebols — or economic groupings — that dominated the Korean economy. Now, it has finalized a deal that sells its key assets to U.S. automaker General Motors.
Daewoo’s rise from literally nothing in the 1960s — and its collapse in the late 1990s — exactly traces the economic arc of modern Korea. It represented Korea’s ability to move from being a poor agricultural economy to a country that was deemed soon to be on a par with Japan first — and then the United States.
In the process, the nation soared from a few hundred dollars of per capita income to relative riches. The average annual income level rose above the $16,000 level per person — before coming down significantly due to Korea’s financial crash in 1997.
To regain the road to rapid growth, Korea has struggled in recent years to reform its banks, as well as its anti-corruption laws and its labor contracts.
Daewoo’s main auto operations spent over two years in bankruptcy before a deal was announced in September 2001. Detroit-based General Motors came to the rescue after Ford Motor Company, Toyota and Korea’s own Hyundai considered bids — but then backed away.
When the financial crisis hit Korea a few years ago, Daewoo was struck with two serious issues. The first was wild over-expansion. The second was wild over-commitments to high pay levels and job security.
Like many other big Korean corporations, Daewoo during its glory days was supplied with almost unlimited bank lending. The company used the flood of money to expand at home and abroad. But it did so without regard to actual sales of its autos — or a realistic assessment of future sales prospects.
Worse yet, this loose system of corporate finance involved bribes and kickbacks to corrupt bank officials and political leaders. Two successive presidents of the Republic of Korea in the 1980s and early 1990s were later sentenced to death (since commuted) for their part in that orgy of corruption. One of the presidents was discovered to have $640 million in bribes in his own personal bank accounts.
By the late 1990s, the entire Korean auto industry had created a production capacity to export 5 million cars a year. The trouble was that, at the time, Korea was exporting only 1.25 million cars annually.
At the same time, Korea’s communitarian social code — like those in Japan and elsewhere in Asia — had led the government to enact legislation. This legislation encouraged labor contracts to embody life-time job guarantees in the auto industry and other modern export sectors. It seemed only fair. After all, these were the very sectors that were receiving the vast floods of easy money backed by the government.
When the roof fell in on Daewoo management in 1999, it was stuck with a labor force far larger than its immediate production needs required. In addition, its workforce was compensated at the highest pay scale levels in Korea.
And on top of that, Daewoo was the most overextended of the country’s three major auto companies — Daewoo, Hyundai, and Kia. Daewoo not only had four big plants at home, but also a dozen abroad. As a result, it crashed into the biggest bankruptcy in Korean history — involving $19 billion in assets.
Ever since that calamity occurred, Korea’s fiercely contentious unions have tried to insist that all its labor contracts are valid. Understandably from their perspective, the unions also insisted on keeping both the high wage levels and all job slots, whether needed or not.
In response, the strategy of the government — and of the now reformed, government-backed banks that currently control Daewoo — has been to engage in the equivalent of a war of attrition. They are trying to wear down the unions.
In essence, the only choice available to the government and banks is to sell the factories for what they are worth in an oversupplied international car market. And that is only a fraction of the initial investment.
The reason why the banks and the government are nevertheless keen on getting these factories back into long-term competition is the hope that the factories will provide future opportunities for employment growth. Still, Korea’s labor unions are attempting to resist any reduction in the number of jobs even if those workers would be idle.
One of Daewoo’s best Korean factories was sold earlier to a combine of Renault and Hyundai. Now, U.S.-based General Motors, and one of its four traditional international allies signed a $1.2 billion deal to take over 67 percent of the struggling company.
The GM purchase of Daewoo was carefully crafted. It reforms those of Daewoo’s business practices that got the company and Korea into trouble in the first place. And when reforms are not yet possible, it detours around them, by leaving government-backed creditors holding the unreformed part of the Daewoo bag.
The continuing cost to Korean taxpayers, who have already absorbed the $19 billion in bankruptcy losses, is huge. GM has made a tenuous commitment — promising to use Daewoo’s oldest, biggest and most union-encumbered factory at Bupyong only over the course of the next six years. It also rejected other money losing factories in several other countries.
Under the original September agreement, GM assumed only $830 million of Daewoo’s union pension, severance pay and other liabilities while obtaining inventories valued at $980 million.
Says Henry Wong, a GM executive helping in the deal, “GM definitely did not take the labor situation lightly. We didn’t take on a pension or benefit burden that the enterprise cannot carry.”
For the Korean government, it is still probably a good deal, if a horrible lesson in the consequences of corrupt banking. It gets important national assets back into world competition. And the deal itself sends a political and economic message to its citizens, especially to the labor union holdouts.
Sooner or later, they will come to realize that their choice is simply this: Either you accept the reality of flexible labor markets and competition in the world economy. Or you are slowly going to wither on the vine.
What does this suggest for the future of Korea? Daewoo’s breakup — and, more significantly, the willingness of the Korean government to participate in the breakup — clearly signals the end of the chaebol era. Korea has already eliminated 14 of the 30 giant “chaebol” combines — and Daewoo represents the biggest dismemberment yet.
But Korea may now be positioned to pull off the next step, which is a transition to a more U.S.-style corporate governance system. Reforming the chaebol and selling off the profitable parts of Daewoo, is exactly what is needed to get the economy back on the growth track. And that is the case even if the buyers of this major symbol are foreigners.
Korea’s willingness to entertain such a change suggests that it may yet even surpass Japan. Japan, the original model for Korea, continues to prop up all its own giant business combines, called “zaibatsu.” And its government and banks — despite all the proclamations favoring “real reforms” — apparently do not know what to do other than continuing to pile up endless loans.