democratization, dispersed interest groups, and economic reform in south korea: understanding the...

DEMOCRATIZATION~ DISPERSED INTEREST GROUPS, AND ECONOMIC REFORM IN SOUTH KOREA: UNDERSTANDING THE DECLINE OF THE ~CHAEBOL REPUBLIC ~*

Shale Horowitz

The 1997financial crisis exposed serious weaknesses in South Korea's economy, with its heavy reliance on large conglomerates (chaebol). Dur- ing the late authoritarian period, the chaebol arose through state guid- ance and subsidies, becoming the central players in South Korea's export-led growth boom. The early democratic period saw limited efforts toward economic liberalization. But these measures reduced state oversight while actually expanding the privileged access to credit enjoyed by the chaeboL The resulting investment distortions and financial weaknesses were the most important root causes of the 1997 crisis. The 1997presi- dential election brought the outsider Kim Dae-jung to power. Kim launched an unprecedented assault on the credit privileges and corporate governance structures of the chaebol. However, the reforms have been compromised by measures to prevent a large transitional recession. It is argued that the overall pattern of ambitious but compromised reform is explained

82 East Asia / Spring 2002

by two main considerations. First, Kim did not want to alienate "dispersed interest groups" (the urban service sector and agriculture). These want to conserve the favorable elements of South Korea's economic model while purging the dross. And at the same time, Kim wanted to focus transitional restructuring costs on the most hostile "concentrated interest group'" constituencies (the chaebol and government sectors) of the opposition Grand National Party.

South Korea enjoyed phenomenal economic growth from the early 1960s to the mid-1990s (Root 1999). However, growth slowed in the 1990s. In 1997, South Korea was wracked by a foreign exchange crisis, forcing her to request an International Monetary Fund (IMF) bailout (Chosun Ilbo, 30 December 1997). Experts reported that the most immediate financial causes of the crisis were excessive dollar-denominated short- term loans and a shortage of foreign exchange reserves. But there were other, more fundamental factors involved.

Over the previous decade, state oversight over both big business conglomerates (chaebol) and organized labor had been largely dismantled. This led to increasingly risky investment programs and uncontrolled wage increases, thereby undermining the foundations of the "Korean miracle." The South Korean mass electorate, before 1997 wary of attacking an economic policy regime with such an outstanding growth record, now became more reformist. The liberalizing reforms that have followed the 1997 presidential election were dramatic, though somewhat inconsistent. This pattern is explained by Kim Dae-jung's efforts to accommodate changing economic policy preferences without unduly risking his party's future electoral prospects.

Before the crisis broke out, South Korea had embarked upon an aggressive political liberalization effort alongside a gradual process of economic liberalization. Political liberalization efforts included removing legal restrictions on labor union organization and collective bargaining; providing greater legal protection of speech and press freedom; and insti- tuting campaign finance reforms, a direct popular presidential election, and local government autonomy (Kil and Moon 2001; Mo and Moon 1999; Oh 1999). The increased powers of organized labor led to increased labor activism and rising wages (Cheng and Krause 1991; Moon and Kim 1994). For instance, from 1990 to 1996 the average

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number of lost workdays from strikes was seventh in the world (Chosun Ilbo, 5 April 1998). From 1992 to 1996, real earnings of the manufacturing sector increased at an annual rate of almost 8 percent (Smith 1998). This led to an increase in the cost of exports and reduced international competitiveness.

At the same time, gradual economic liberalization undermined state oversight over chaebol investment, without adequately substituting market-based constraints. The old state efforts to guide investment into particular sectors had been dismantled during the early 1980s, prior to democratization. Following democratization, gradual financial sector liberalization increased the already privileged chaebol access to domestic and foreign capital. The state regulatory oversight and foreign financial sector competition necessary to reduce and diversify risk was notably lack- ing. As a result, the largest chaebol absorbed much greater investment resources and sunk them into large projects in a small number of presti- gious, but relatively unprofitable product lines (Byrne 2001; Economist, 11 November 2000, 75-6, 11 August 2001, 49-50; Lim 2001).

Prior to the 1997 crisis, liberalizing reforms occurred gradually, and were fiercely and effectively resisted where they threatened to undermine the basic properties of the old economic regime. It was only in response to the crisis that fundamental changes were made. These reforms focused on changing the financial and legal regulations that insulated chaebol owners from market and shareholder discipline, and on changing capital markets from captive sources of chaebol financing to more neutral and competitive intermediaries. Although significant advances have been made on both fronts, reforms have been somewhat compromised in their overall stringency and have been enforced with some inconsistency.

This paper seeks to explain why economic liberalization acceler- ated in this manner following the 1997 crisis. It argues that the most important factors were changing economic policy preferences among the mass electorate, combined with accommodating democratic institutions and political leadership. While the accommodating democratic institutions and political leadership were important in producing a policy response to changing public opinion, they also account for the ways in which market reform continued to be compromised.

The paper consists of four main parts. The first advances a framework that analyzes how important economic interest groups mobilize and


form policy preferences in a democratic institutional context. The next part applies the framework to South Korea. The third part reviews economic policy changes since 1987, and the fourth discusses the political sources of the economic policy changes.

Economic Interest Groups and Political Institutions: Mobilization, Preferences, and Leverage

The political economy literature is concemed with two primary types of economic interest groups, which can be termed "concentrated" and "dispersed" As compared to dispersed interest groups, concentrated interest groups have lower costs and higher benefits from political mobilization. The lower costs tend to derive from concentration of production in larger and more spatially contiguous units of production. The higher benefits tend to derive from production of more homogeneous goods, which can more easily be targeted by policy interventions on the production side. These interventions can take the form of taxes or regulatory barriers de- ployed against foreign (or domestic) competitors, or fiscal, credit, and regulatory subsidies for producer firms. Concentrated industries also employ a smaller share of the workforce, so it is possible to intervene more exten- sively in their favor.

By contrast, the higher mobilization costs for dispersed groups derive from smaller size and greater dispersion of productive units. And dispersed groups' lower benefits are due to production of more heterogeneous goods, which cannot as easily be targeted simply and uniformly by centralized policy interventions. Interventions in favor of dispersed groups hence more frequently occur on the consumer side, irrespective of differences in their productive activities. Finally, dispersed groups employ a larger share of the workforce, so it is much more difficult to finance uniformly more extensive intervention in their favor.

These differences lead to the traditional explanatory focus on concentrated interest groups. Since concentrated interest groups have lower costs and higher benefits from political mobilization, they have stronger incentives to become informed about the consequences of different economic policies, and to mobilize in favor of those policies that benefit them and against those that hurt them. In comparison, dispersed interest groups would be expected to remain more poorly informed and politically inac-

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five. Where policy outcomes can be explained exclusively in terms of concentrated interest group preferences and mobilization, therefore, other factors are sometimes neglected.1

On the other hand, the pattern of concentrated interest group activ- ity for and against given policies often cannot provide an adequate explanation of fundamental economic policy change. For example, this occurs in the following situation. Suppose the economic policy regime has tilted strongly in favor of a particular coalition of concentrated interest groups. If this situation persists for some time, this concentrated interest group coalition will grow much larger and wealthier than their concentrated interest group opponents. If they were able to win the policy struggle to begin with, and if they grow even more numerous and wealthy, how is it that the policy regime discriminating in their favor could ever be politically reversed? In this situation, dispersed interest groups are often brought back into the explanatory framework. The argument is that, when the actual or perceived effects of the existing policy regime become highly negative for the economy as a whole, dispersed interest groups will become more informed and mobilized in favor of policy change. Then the process repeats itself. The dispersed groups retreat into quiescence, and concentrated groups enjoy relatively free rein until the dispersed groups are once more provoked to embrace policy change.

It should be noted that there is still some ambiguity about the policy preferences of dispersed groups. Is it that these groups do not have clear policy preferences until there is some kind of crisis, or that they change their policy preferences under the impact of crises and other events, or both? It is likely that both processes are common, although their relative importance is an empirical question. In any event, it does not seem justified to make the assumption that dispersed groups are normally politically detached and inactive. If such detachment and inactivity are not assumed, then the model would be somewhat different, as follows. Although concentrated groups may take the initiative with policies that affect them most directly, dispersed groups are somewhat informed and mobilized. In that case, the numerical preponderance of dispersed groups potentially gives them a veto over the economic policy regimes whose more detailed de- signs are specified by concentrated groups and government elites.

Given that many economic policies have only a delayed and indi- rect impact on dispersed economic groups, it is important to discuss briefly


how their preferences are likely to be formed and changed. Here the most sophisticated framework is provided by the macroeconomic policy literature. The basic argument is that dispersed groups judge policies by their results over time, rather than by debating the relative merits of complex economic models. 2 This implies that they can be fooled for a time by distortionary redistributive policies whose costs are imposed indirectly and over the longer run. Initially, they do not perceive significant costs counterbalancing the clearer benefits that usually accrue primarily to various concentrated groups. So they will support, or at least not oppose, the relevant redistributive policies. However, as they acquire experience with the longer-term negative consequences of distortionary policies--which typically become evident in the form of greater cyclical instability and lower long-term growth rates--they are likely to shift their support to liberalizing remedial policies. There is a second level of theory that complements this basic model of learning. The idea here is that worldwide, regional, and country-specific ideological trends can influence the learning process--either by speeding it up or slowing it down. Historical experiences of various kinds can produce biases for or against either more interventionist or more liberal economic policies (Horowitz 2001). 3

The discussion so far points up the importance of putting the interest group model into a specific institutional context. We are discussing policy outcomes in democratized (post-1987) South Korea. Democracies provide a regular institutional channel for dispersed groups to make their numerical advantage felt. This provides an institutional guarantee that concentrated groups will have difficulty imposing their preferred policies against significant dispersed group opposition. Concentrated groups must continue to be able to "sell" their preferred package of policies to a suffi- ciently large dispersed constituency.

Different institutional forms of democracy may create mobilization advantages or disadvantages for different interest groups. For example, it is often argued that executive and legislative systems that concentrate power, and electoral systems that create a tendency towards concentrated party systems, make it easier for dispersed groups to impose their preferences. On the other hand, constitutions that disperse power across mul- tiple executive and legislative bodies, and electoral systems that tend to form fragmented party systems, make it easier for concentrated groups to

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block initiatives supported by dispersed groups (Haggard and Kaufman 1992; Tsebelis 1995). 4 We now apply this framework to South Korea's political economy.

Applying the Framework to South Korea's Political Economy

What concentrated and dispersed interest groups have been most prominent under South Korean democracy since 1987? As will be discussed in more detail below, policy under the authoritarian regime created increasingly large export-oriented industrial conglomerates (chaebol). The chaebol have become much larger and more regionally concentrated than is the case for big business in most other countries. Unsurprisingly from the organizational and resource-extraction perspectives, these conglomerates also became a stronghold of organized labor. Thus the most important concentrated interest groups have been the chaebol owners and managers on the one hand, and their labor organizations on the other. Despite frequent clashes over wage settlements, these concentrated groups have shared interests in maintaining the huge subsidies that the government has traditionally provided to the chaebol. There are concentrated groups that oppose these subsidies, since they have not benefited significantly from them. These include smaller exporting firms without important business ties with the chaebol, and many foreign-owned enterprises. However, these firms are relatively small and poor compared to the chaebol.

It is useful to distinguish three primary dispersed groups. In the burgeoning cities, there are the more highly skilled middle classes and less skilled unorganized labor. These groups are primarily employed in di- verse, small-scale service industries. Hence it is more difficult for them to organize, and their heterogeneous businesses are not easily targeted by centralized economic policy. In the countryside, thirdly, there are peasant- farmers. This group is often lumped in with urban dispersed groups. But in most cases this is not warranted. Farmers produce unusually homogeneous products for such a large dispersed group. Hence it is easier for centralized policy to target them in their capacity as producers. Farm- ers are therefore typically more organized and more politically influ- ential than urban dispersed groups, and as a result are more likely to benefit from significant subsidies. These subsidies tend to increase as


the growth of the urban economy generates more resources for redistri- bution. As a result of migration to the cities, peasants are no longer the predominant group they once were. But they are still of potentially pivotal political importance?

The key question about these dispersed interest groups involves their "learning" about the impact of chaebol-centered credit, trade, and regulatory policies. Theoretically, one would expect that most would hesitate to turn against the old economic policy regime for as long as South Korea continued to enjoy healthy growth rates. One must also consider how economic policy learning was influenced by a complex of historically specific factors. These include Korean national identity, the Korean War and the subsequent division of the nation, the North Korean military threat, Korea's democratization, the end of the Cold War, and the rise and fall of the Japanese (or "East Asian") development model.

Korea's ancient history as a nation-state has made her national identity quite strong in relative terms, more similar to that of Japan and China than to most other East Asian states. This can be seen, for example, in the relative strength of resistance to Japanese occupation. This strong national identity was then violated by the devastating Korean War and the continuing post-war partition, and subjected to an immediate overriding threat of a new and similarly devastating war. This contributed to a siege mentality among both elites and masses, leading to a focus on building economic strength as a means of providing added military security. The economic policy regime chosen by South Korea's military dictators consciously imi- tated and even exaggerated the methods thought to have been used in Japan after World War II. All of these ideological factors added a bias in favor of the chaebol-centered policy regime while it continued to deliver high growth rates (Eckert 1990; Steinberg 1989).

However, the late 1980s and early 1990s brought a range of countervailing ideological influences. The Korean democracy movement was victorious by 1987, and the economic policies of the authoritarian era were tarnished by their association with the military dictators' repressive excesses. Soon afterwards, Mikhail Gorbachev's political liberalization was followed by the sudden collapse of the Soviet Empire in Eastern Europe and Mongolia, and then by the collapse of the USSR itself. This undermined the economic and military strength of Moscow's old North Korean client, much reducing the threat of North Korean invasion. Fi-

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nally, the collapse of the Japanese asset price bubble and the associated banking sector weakness, when combined with an immobile dominant party political system, plunged Japan into seemingly permanent stagna- tion. At the same time, the U.S. economy reemerged as the undisputed leader in advanced technology industries. These events of the late 1980s and early 1990s reduced the perceived risks of deviating from the old economic regime, and increased the attractiveness of the rival liberal and liberalizing models.

To summarize the situation prior to the 1997 financial crisis, the strong early ideological bias in favor of a Japan-like model of state-led development--as a means of acquiring greater military strength and as- suring national political survivalmwas steadily eroded from the late 1980s. These trends would be expected to increase the "learning" impact of Korea's 1997 financial crisis, making it possible to achieve a broader liberalizing reaction in dispersed interest group policy preferences. How- ever, South Korea's remarkable economic performance would still be expected to give dispersed interest groups a fundamentally conservative, cautious attitude about making changes to the old economic policy regime. Moreover, any new system would have high standards to live up to. Significant and protracted economic setbacks under a new policy regime would predictably generate relatively strong support for a return to the older model.

South Korea's revised democratic constitution created a single legislative body and a strong presidency. Also, the party system has become increasingly concentrated over time, largely under the influence of what has remained a predominantly single-member district-based electoral system. Thus, in 1987 there were three large parties and a number of smaller ones, and there have since been uneven but noticeable tendencies toward a system of two large parties. 6 Hence, policy change since 1987 has required the agreement of the president and a majority legislative coalition. Legislative coalitions have consisted of one or two large parties, along with various combinations of smaller parties, party splin- ters and independents (Kil and Moon 2001; Oh 1999). After a review of economic policy developments before and after democratization, these interest group and institutional elements will be used to offer an explanation of economic policy change before and after the 1997 financial crisis.


South Korea's Old Economic Policy Regime and the Post-Crisis Reforms

In the early 1960s, South Korea's foreign economic policy regime shifted from import-substitution to export promotion. Prices were liberalized, and competitive interest rate and exchange rate policies adopted. Although the domestic market remained highly protected, exporters were given duty-free access to inputs. The government cooperated closely with business to promote exports, with all exporters obtaining non-discrimina- tory access to credit. From the early 1970s, with the Heavy and Chemical Industries Plan, government adopted a more strongly interventionist ro l e . 7

More capital-intensive manufacturing industries were promoted through industry-specific targets, and compliant firms were heavily subsidized through a variety of instruments--above all access to virtually unlimited credit lines. It was this period that gave birth to the huge conglomerates (chaeboI) that continue to dominate the Korean economy (Ahn 2001, 13- 5; Haggard 1990, 51-75, 130-8; World Bank 1993, 127-30).

Beginning in the 1980s, there was some gradual rationalization and liberalization of the chaebol-led development regime. Subsidies were reduced, government-directed development planning was phased out, and trade protection was dramatically slashed. However, the chaebol charac- teristics and their government-backed access to credit remained largely unchanged. Chaebol governance was firmly in the hands of the founding families. In 1997, cross-shareholdings among chaebol affiliates inflated average 8.5 percent family shareholdings in the top thirty chaebol to a decisive 34.5 percent average shareholding through affiliates. Weak minority shareholder rights, insider-dominated boards of directors, and strong regulatory barriers against hostile takeovers further solidified family control. The chaebol were perceived as too large for the government to let fail. This led creditors to ignore ordinary lending criteria, and chaebol owners to expand at an increasingly untenable rate. The situation was exacerbated by financial disclosure rules, which allowed the chaebol to conceal their anemic operating profits through a variety of inter-affiliate accounting devices. Consolidated accounts for 1999 revealed that nine of the sixteen largest chaebol did not have operating incomes sufficient to cover their interest expenses (Alan 2001, 15-6; Park 2001, 34-8; Shin and Ha 1999, 70-5).

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These perverse incentives to engage in excessive and risky borrow- ing were exacerbated by the financial liberalization process of the 1980s. As government oversight of the banking sector receded, the chaebol themselves spearheaded the development of the newly deregulated non-bank financial sector. The entire financial sector had improved access to international sources of funds. The lending excesses of the banks were sur- passed by the chaebol-dominated non-bank financial sector. The non-bank sector's share of deposits rose from 29.1 percent in 1980 to 72.2 percent in 1995. Much of this money was invested in corporate bonds guaranteed by financial intermediaries. The four largest chaebol--Daewoo, Hyundai, LG, and Samsung--were responsible for over two-thirds of all corporate bond obligations outstanding in 1997 (Byme 2001, 25; Lim 2001, 29-30).

The proximate causes of the 1997 international financial crisis were low foreign exchange reserves, large short-term international debt obligations, and an investor flight to quality. However, as Lim (2001, 29) points out, even if larger reserves and more limited international obligations had forestalled a currency crisis, Korea would have experienced a bad loan- related bank and non-bank financial sector crisis. At the same time, the high interest rates and sharp recession that followed deepened the financial difficulties of the highly indebted corporate sector.

The crisis precipitated significant reforms in a number of areas, in- cluding labor markets and the state administration. After much political wrangling, limited labor market reforms were approved in March 1997. Under the impact of the crisis, however, much more dramatic changes were made. In addition to easing layoffs, these included creating various limited-obligation employment categories and more flexible pay systems. Plans were also announced to expand the social safety net, streamline the civil service, and privatize state-owned enterprises.

But the most dramatic reforms have been in corporate governance and the financial sector, the keys to the old system of chaebol privilege. Rule-based governance reforms include more stringent, internationally- recognized accounting and disclosure rules, stronger minority shareholder rights, more independent boards of directors, and reduced barriers to foreign investment and hostile takeovers. In addition, the government has used its financial leverage to push the chaebol to rationalize their over- diversified operations and reduce their debt-equity ratios. The number of affiliates of the top thirty chaebol was reduced from 821 in 1997 to 584 in


September 2000. The aggregate debt-equity ratio of Korean firms fell from 3.96 in 1997 to 1.93 in June 2000. The government also signaled that the chaebol were not too large to fail. The second largest chaebol, Daewoo, went bankrupt in 1999, and seventeen of the forty-one chaebol have been involved in some kind of creditor- or bankruptcy-imposed restructuring regime. Despite South Korea's post-crisis economic recovery, chaebol debt loads remain high and their profitability low. Financial difficulties have forced deep restructuring in Daewoo and to a lesser extent Hyundai, but the medium-sized chaebol have made the largest adjustments (Ahn 2001, 16-21; Byrne 2001, 26; Economist, 14 November 1999, 67-8; Financial Times, 29 October 2002; Park 2001, 36-8).

In the financial sector, the government has been forced into a costly bailout effort. Many banks had to be closed, and others recapitalized and consolidated. Predictably, bad loan problems have been even more extensive in the non-bank sector, among the investment trust, securities, and insurance companies. The first bailout effort of 1998 had to be supple- mented by a second in 2000, which focused on the weaker non-bank sector. Through 2000, the total effort had already cost more than 20 percent of GDP. The government has liberalized foreign financial sector investment, but many banks and non-bank financial firms remain in state hands. Moreover, the government has felt forced to intervene to prevent new crises from occurring. In the non-bank sector, there was a huge bunch- ing of bond maturities in 2001. To avoid a credit crunch that might undermine the recovery, the government-controlled Korea Development Bank guaranteed a rollover of 80 percent of bonds outstanding in a range of troubled companies--among the most notable of which were a number of core Hyundai affiliates. A similar kind of ambiguity prevailed in the banking sector. Here debt workout arrangements were to be depoliticized by putting them under bank control. But most banks were controlled by the government, and were hardly inclined to cut off traditional borrowers without direct government pressure. The government has made some efforts to privatize commercial banks to deep-pocketed foreign firms, but resistance to low sale prices, foreign ownership, and expected layoffs have slowed progress (Agence France-Presse, 9 December 2002; Byrne 2001; Economist, 10 July 1999, 8-9, 5 May 2001, 69; Financial Times, 6 Janu- ary 2003; Korea Herald, 6 January 2003; Lim 2001, 30-1; OECD 2000, 15-6, 182-5, 260-82).

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As a result of the governance, financial sector and labor market reforms, the foreign presence in Korea has been dramatically increased. Direct foreign investment (DFI) surged from $3.2 billion in 1996 to over $10 billion per annum in subsequent years. There was a similarly massive increase in portfolio investment, with foreigners owning about 30 percent of Korean shares by 2000 (Korean Herald, 24 January 2003; Park 2001, 36-8).

Explanation of Pre-Crisis and Post-Crisis Policy Changes

Here we will contrast the development of economic policy before the 1997 crisis with post-crisis changes. The observed pattern is that pressure for liberal reforms built gradually, but was effectively resisted until the 1997 crisis. Dramatic reforms were made in the months immediately following the crisis, but subsequent advances were more limited and difficult. We argue that this broad pattern cannot be explained without reference to changes in dispersed interest group preferences. However, the specific forms taken by policy changes must be explained in terms of how increased dispersed interest group support for liberalizing reform was accommodated by South Korea's political institutions, party system, and leaders. Political parties and leaders were constrained by dispersed interest group preferences and political institutions, but had considerable autonomy within these constraints.

The pre-crisis decade of economic policymaking (1987-97) was characterized by two broad trends: gradual liberalization that did not directly challenge the chaebol-centered policy regime, and an intensified struggle between chaebol management and organized labor over division of the spoils. On the one hand, dispersed interest groups--particularly the middle classes and the peasants--wanted to conserve the basics of the economic system that had brought South Korea from rags to riches in little more than a single generation. On the other hand, the old regime's political bias against organized labor could not be justified under democracy, and organized labor used this opening to seize an increased share of the rents and profits generated by the chaebol. It is important to understand that the conflictual relations between chaebol owners and managers and organized labor concealed a fundamental symbiosis. Both depended on the old economic policy regime to deliver elevated incomes, 8 and giving organized labor a bigger piece of the pie increased concentrated interest group unity in defending the essentials of the system--particularly pro-


tected home markets, privileged access to investment capital, and the im- plicit state guarantee to bail out firms considered "too big to fail."

These trends made the chaebol system increasingly untenable economically and financially. Gradual liberalization increased "moral haz- ard" in capital markets. Chaebol retained their privileged access to investment capital, while financial liberalization weakened government oversight, allowed the chaebol themselves to dominate newly developing securities markets, and for the first time provided access to international as well as domestic sources of capital. The chaebol made massive invest- ments in developmentally fashionable sectors such as autos and commod- ity semiconductors, even though these sectors were already besieged by global overcapacity and weak, highly cyclical profitability. At the same time, wages rose much faster than productivity, undermining chaebol competitiveness (Oh 1999, 113, 197). Chaebol profitability declined, the chaebol were able to sustain their expansion only by swallowing a rising share of investment, economic growth slowed, and chaebol debt-equity ratios swelled to unsustainable levels. These were the underlying weaknesses that made the South Korean economy relatively vulnerable to the international flight to quality of 1997.

This process was recognized early on by dispersed interest group opinion. But doubts about how to respond, in the context of a generally conservative outlook, generated only weak, ineffective efforts to head off a crisis. In 1987, the authoritarian leader Chun Doo-hwan's right-hand man, Roh Tae-woo, was elected president. This reflected both a desire to conserve the economic achievements of the old regime, and the division of the opposition vote between pro-democracy opposition leaders Kim Young-sam and Kim Dae-jung. Roh's conservative party did even better, winning almost as many votes as the parties of the two Kims combined. (See Tables 1 and 2.)

The new political and legal freedoms led almost immediately to an explosion of long-repressed organized labor activism. Repeated strike waves pushed wages up at an unprecedented rate and eroded investor confidence. The economy slowed, and dispersed interest group opinion shifted its concerns from political reform towards economic stability. This economic instability and uncertainty persisted through 1993.9 In January 1990, South Korean politics was rocked by the announced merger of the parties of Roh, Kim Young-sam, and Kim Jong-pil into a center-right su-

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per-party, the Democratic Liberal Party. 1~ In the 1992 parliamentary elections, the Democratic Liberal Party was barely prevented from winning an absolute majority when Hyundai founder Chong Ju-yong formed a new party, thus splitting the center-right vote. Yet the Democratic Liberals were able to form a majority with the support of some independent legislators. Kim Dae-jung's Democratic Party remained the dominant opposition party. In the 1992 presidential election, KimYoung-sam won a clear victory over Kim Dae-jung--despite Chong's third-party candidacy--as a worried electorate again signaled its emphasis on stability over reform.

KimYoung-sam's administration emphasized political and military reforms 11 rather than economic reform. Amid continued labor unrest and economic uncertainty, economic policy turned towards gradual liberalization. Deregulation in general, and financial liberalization in particular, were the main means chosen to increase domestic and foreign competition, and to correct the old financial market bias favoring the chaebol over small and medium enterprises. However, as discussed, these reforms simply re- moved government oversight, while leaving the chaebol in a privileged position. Not only did the chaebol continue to draw the lion's share of credit from the banking system, but their new financial affiliates also directly controlled most of the burgeoning non-bank financial sector.

Table 1

South Korean Presidential Election Results (Percent Share of Votes)

Roh Tae-woo

Kim Young-sam

Kim Dae-jung

Kim Jong-pil

Chong Ju-yong

Lee Hoi-ehang

Rhee In-je

Roh Moo-hyun

Others

16 December 18 December 18 December 1987 1992 1997

36.6

28.0 41.4

27.0 33.4 40.3

8.1

16.1

0.3 9.1 1.8

38.7

19.2

19 December 2002

46.6

48.9

4.5


Table 2

South Korean Nat ional Assembly Elect ion Results (Number o f Seats Won)

Democratic Justice Party (Roh Tae-woo)

Party for Peace and Democracy, Democratic Party, 70 National Congress for New Politics (Kim Dae-jung)

Republican Democratic Party 59 (Kim Young-sam)

New Democratic Republican Party, 35 United Liberal Democratic Party (Kim Jong-pil)

Democratic Liberal Party, New Korea Party, Grand National Party (Roh Tae-woo, Kim Young-sam, initially Kim Jong-pil)

Unification People's Party (Chung Ju-yong) Democratic Party (Yi Ki-taek) Others 10 Total 299

26 April 24March 11 April 13 April 1988 1992 1996 2000 125

97 79 115

50 17

149 139 133

31 15

22 16 8 299 299 273

Note: Party name changes have been common. However, there has been continuity of leadership and usually also of organization. Beginning with the 2000 elections, the number of seats was reduced from 299 to 273.

Following a brief recovery in 1994-95, the economy began to weaken again in 1996. At this stage a sharp political battle was fought over proposed labor market reforms. The compromise that ultimately emerged le- galized layoffs under conditions of financial emergency, and made it easier for management to resist strike pressures. 12 Additionally, a financial reform bill was submitted in August 1997. This bill was an attempt by the government to consolidate the supervision of commercial and merchant banks, and to grant the Bank of Korea greater autonomy. As with the labor legislation, it was stalled in the Assembly and did not pass until the crisis broke out (Heo and Kim 2000).

In January 1997, Hanbo Steel went bankrupt under the pressure of $6 billion in debt. It was the first bankruptcy of a leading chaebol in a decade. What made it more troubling were subsequent mass media re- ports concerning the large-scale bribery efforts and kickbacks directed at government officials and legislators, who pressured for large loans with-

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out conducting proper examinations of business plans or securing collat- eral. A flood of other chaebol bankruptcies followed over the next few months. The central bank was soon forced to make emergency loans to prevent a large number of domestic banks from defaulting on their obligations. The won had to be sharply devalued, and asset prices collapsed. In November the government agreed to a massive IMF-led bailout, in exchange for promises of financial sector restructuring and liberalization, corporate restructuring, corporate governance reform, and labor market reform (Heo and Kim 2000).

The December 1997 presidential election was won resoundingly by Kim Dae-jung. (See Table 1.) Kim Dae-jung's prospects were somewhat improved by a pre-election alliance with Kim Jong-pil (who agreed to offer his support in exchange for being made Prime Minister in the new government), and by a split in the Grand National Party (Rhee In-je ran against Lee Hoi-chang in the presidential election after failing to win the party nomination). However, in ideological terms, all of these candidates represented center-right or right competitors. Kim Dae-jung no longer faced a right competitor (Kim Jong-pil), but had to run against an additional center-right rival (Rhee In-je). Thus, it is difficult to explain the significant absolute increase in Kim Dae-jung's vote share without reference to the 1997 economic crisis. The crisis for the first time strongly discredited the chaebol-centered policy regime in purely economic terms. Increasing num- bers of dispersed interest group voters now viewed the South Korean economic miracle as something that did not depend on chaebol leadership, which arguably hurt the economy as much or more than it helped it. Many observers spoke of a new political consensus on reforming the chaebol-centered system. Voters surveyed at the time of the 1997 election overwhelmingly viewed the economy as the most important issue facing the country. Of this economy-focused group, 52.8 percent said Kim Dae-jung was best able to deal with the problems, as compared to only 24.6 percent for Lee Hoi-chang (Park 1999, 133; Shin and Ha 1999, 75-6; Yoon 2000, 169). 13

Rather than try to legislate reforms in cooperation with the opposition Grand National Party (GNP), Kim Dae-jung sought to build a majority coalition of his own National Congress for New Politics (NCNP), Kim Jong-pil's United Liberal Democrats (ULD), and GNP defectors. The GNP was embittered by the nearly half a year it took to attract away the necessary number of its legislators--particularly since it often appeared


that state corruption prosecutions were sometimes used as a political weapon in the effort. In January-February 1999, the process finally made possible a raft of economic reforms. As discussed, these focused on bank revitalization and restructuring, on chaebol restructuring, debt reduction and governance reform, and on labor market reforms (Kim 2000, 894-6; Park 1999; Yoon 2000).

Just as these reforms were pushed through, a remarkably rapid economic recovery began. This in turn weakened the political consensus in favor of further reform, and little more was accomplished in the remainder of the year. ~4 Given that parliamentary elections were due in April 2000, Kim Dae-jung had to be especially cautious. During the campaign, Kim's NCNP--renamed the Millennium Democratic Party (MDP)---defended the economic reforms as necessary to South Korea's economic recovery and future growth. By contrast, the GNP attacked the measures as excessively harsh, and particularly opposed distress asset sales to foreigners (Economist, 15 January 2000, 40-1; Korea Herald, 7 April 2000).

The mass media have tended to view the elections as a narrow victory for the GNP. ~5 This is because the GNP nearly won an absolute majority, despite the economy's rapid recovery from the crisis. However, this criterion is misleading. First, it is clear that the ULD was the big loser. Second, compared to the 1996 election results, the MDP picked up a much larger share of ULD and small-party losses than did the GNP. Thus, MDP gains narrowly sufficed to form a majority with ULD and other represen- tatives (Chosun Ilbo, 14-15 April 2000; Hankook Ilbo, 30 May 2000; Horowitz and Kim 2002; Kim 2000, 898-909).

Soon after the elections, the economy weakened. ~6 At this point, Kim had little choice but to try to accelerate reforms anew. If the restructuring policies did not deliver economic results, he would be blamed. If he cut back on reforms and returned to a more interventionist policy regime, he would be admitting that the entire reform enterprise was misguided and that the associated transition costs were borne in vain. The proposed second round of reforms attempted to complete the financial sector's restructuring and rehabilitation, to speed restructuring of large private and public enterprises (especially through privatization, above all to foreigners), and to further increase labor market flexibility. To minimize the short- term social and political effects of the reforms, significant social-safety net enhancements were added.

Horowitz 99

However, a GNP boycott in the Assembly prevented action on most of these measures until late 2001. Meanwhile, the political deadlock appeared to hurt both major parties. There was a temporary increase in Kim's popularity due to the summit with North Korean leader Kim Jong-il and the associated agreements. But in the ensuing months it fell lower than ever under the impact of the continued economic slowdown. Scandals involving corruption in government financial oversight compounded the problem (Ha 2001; Korea Herald, 25 August 2000, 20 September 2000, 25-27 December 2000, 3 July 2001, 1 January 2002).

Kim's government faced an increasingly uphill struggle to restruc- ture weak firms and push through more privatizations. Following the April 2000 elections, the government encountered more determined opposition from organized labor. Clashes between the government and organized labor became the norm. For example, clashes occurred over efforts to sell Daewoo Motors to a foreign investor, to consolidate government-controlled banks, to close a number of bankrupt construction firms, to prevent the privatization of Korea Electric Power Corporation and other state-owned utilities, and to implement labor market reforms. Despite declining public faith in the government, public opinion continued to favor the restructuring measures. This repeatedly defeated union efforts to maintain and broaden strike efforts, just as it forced the chaebol themselves to cooperate with the government (Chosun Ilbo, 25 February 2002; Financial Times, 3 April 2002; Korea Herald, 1 April 2000, 7 November 2000, 1-2 December 2000, 1 January 2001, 19 June 2001, 1 March 2002).

Although Kim doggedly defended financial sector and chaebol reform, the scale of chaebol indebtedness forced the government to guarantee a large-scale rollover of corporate debt in 2001. Even the IMF accepted the need for the rollover in order to avoid systemic financial and economic risks, and Kim's popularity could hardly have survived another deep downturn. The situation again illustrated Kim's basic dilemma. Deep structural reforms were necessary economically, and in the long run were also politically advantageous. But the scale of the necessary reforms were too large to be easily carried out all at once. The government's early reforms were ambitious but still incomplete. This forced repeated policy compromises later, because another large-scale economic crisis was not politically acceptable (Economist, 23 September 2000, 93).

1 O0 East Asia / Spring 2002

This in tum called attention to apparent inconsistencies in govemment reform efforts. Daewoo had been forced into bankruptcy, ~7 and Samsung and LG expected little help from the govemment. On the other hand, Hyundai, which was in serious financial difficulty, was to a large extent bailed out. Was it a coincidence that Hyundai had furnished a costly North Korean investment subsidy for Kim's sunshine policy? Similarly, bankrupt Kia Motors was kept in Korean hands (sold to Hyundai), while the government sold the Daewoo and Samsung auto affiliates to foreigners. Was it a coincidence that large Kia operations were located in the President's Cholla regional stronghold, or that Hyundai was the buyer (Chosun Ilbo, 15 April 2001; Economist, 24 October 1998, 62, 21 Au- gust 1999, 55-9, 19 August 2000, 57, 11 November 2000, 75-6; Finan- cial Times, 1 October 2002; Hankook Ilbo, 24 October 2001; Korea Herald, 29 May 2000)?

With the presidential election coming up in December 2002, Kim's government announced that no new structural reform initiatives would be launched in 2002--although financial and public sector privatization continued to make slow progress. Despite Korea's gradual economic recovery in 2002, corruption scandals involving Kim's sons initially led to plummeting popularity and by-election losses. Kim's MDP successor, Roh Moo-hyun, however, rallied to win the December 2002 presidential election. U.S. troops accidentally ran over and killed two Korean gifts. When a U.S. military court exonerated the soldiers, many Koreans were out- raged and demanded greater accountability to Korean law. At the same time, North Korean nuclear brinkmanship and an uncompromising U.S. response heightened fears that the United States might lead South Korea into unwanted and potentially uncontrollable military hostilities. In addition, a popular third-party candidate agreed to withdraw from the race and support Roh. Although Roh promised to be tougher on chaebol reform than his main opponent Lee Hoi-chang, their economic policy platforms were quite similar and were not an important influence on the election outcome. The cautious but persistent economic reform path charted by Kirn Dae-jung has come to command strong support from the public and the two main political parties (Agence France-Presse, 19 December 2002; Chosun Ilbo, 26 February 2002; Ha 2002; Financial Times, 9 August 2002; Hankook Ilbo, 9 January 2002; Korea Herald, 3 January 2002, 19 December 2002).

Horowitz 101

The overall pattern of post-crisis reform makes both economic and political sense. The chaebol were simply too large and indebted to be made to go cold turkey all at once in weak or uncertain economic conditions. Dispersed interest groups understood that something had gone wrong and that the excesses of the chaebol needed to be corrected. However, the very successes of the old economic regime meant that dispersed groups would only have limited patience during the transitional economic downturn. This led Kim to show some caution in forcing chaebol restructuring and governance changes. This caution in tum constrained Kim later, by creating the possibility of a politically disastrous second downturn if second-stage reforms became too aggressive.

On the other hand, examples had to be set so that the chaebol would see that they had to change their ways. Otherwise, the reforms would weaken the economy without producing a long-term improvement in resource allocation and economic performance. Is it surprising that the President's almost inevitably compromised policies should strike hardest against the strongest concentrated interest group constituents of the opposition? Again, organized labor as well as the chaebol themselves must be viewed as having vested interests in the old regime. Kim's periodic past support of organized labor in management-labor conflicts must be viewed as tactical. His primary electoral support base lies with dispersed interest groups, particularly in Cholla, in the Seoul region and the North, and more recently and to a lesser extent in Chungchong. He has little interest in propping up concentrated interest groups and their economic peripher- ies--especially not those heavily concentrated in the GNP-dominated Kyongsang region. 18 Thus, Kim's ideological statements appealed to dispersed interest groups. They emphasized the need to provide an improved social safety net (primarily benefiting unorganized labor), and to favor small and medium enterprises and peasant-farmers over the chaebol (Ko- rea Herald, 16 August 2001, 29 March 2002; Oh 1999, 232-9).

Conclusion

Following the 1997 crisis, there has been significant but compromised reform of the old chaebol-centered policy regime. This occurred in response to the demands of changing dispersed interest group preferences, in the context of accommodating democratic institutions. Many relatively


conservative dispersed interest group voters inferred from the crisis that the heavy subsidies and biases favoring the chaebol were no longer vi- able. At the same time, reforms have not occurred as rapidly as they might have, and their principles have often been compromised. This occurred because an excessively severe transitional downturn, or a second down- tum following the initial recovery, was viewed as politically unacceptable given the still-conservative outlook of dispersed interest groups. The compromises also appear designed to focus transition costs on political rivals' concentrated interest group supporters. This pattern of reform represents a compromise between Kim Dae-jung's reformist ideological goals and a shorter-term emphasis on his party's electoral success.

At present, the market reforms look to have been significant enough to instill greater financial and managerial discipline among the chaeboI and to achieve an improved allocation of capital and labor resources. The resulting recovery of financial stability and economic growth has made continuing, if still cautious, market reform politically sustainable. Although South Koreans and their political leaders remain fiercely independent and suspicious of excessive foreign influence, they have proven much more realistic and flexible than most expected. As a result, South Korea has emerged more strongly from her economic difficulties than have Japan and the Southeast Asian democracies (Economist, 6 July 2002).

It seems difficult to explain the pattern of South Korean economic policy change without reference to changing interest group preferences. Future work should try to break down variation in support among particular types of dispersed interest groups (middle classes, unorganized labor, peasant-farmers) and different demographic categories (such as age, edu- cation, income, gender, and religion), as well as among the various politically distinct regions. This may shed further light on why reform efforts have been sustained, and at the same time, on how they have been compromised. Also, power was concentrated enough in the presidency and parlia- ment for reform-minded leadership to be able to accommodate shifting dispersed interest group preferences. Kim Dae-jung did not go as far as he might have, but he had the power and will to go further than most expected.

Notes

* I thank Uk Heo and Sunwoong Kim for their helpful suggestions and insights.

Horowitz 103

1. For a discussion, see Alt and Gilligan (1994). Classic works include Gourevitch (1986) and Rogowski (1989).

2. For surveys, see Persson and Tabellini (1990) and Persson and Tabellini (1994). The original literature focused on monetary and fiscal policies, but its logic applies equally to trade, banking sector, and various legal-regulatory policies.

3. For example, the Depression of the 1930s and the experiences of the World Wars created a worldwide ideological bias in favor of more interventionist policies. Anti-colonial ideologies of national birth or renewal created anti-liberal, pro- interventionist biases in Africa after World War II, and anti-interventionist, pro- liberal biases in many former Soviet satellites and Republics in the 1990s. Within authoritarian regimes, similar institutional variations may exist more informally. Agriculture's share of the labor force was around 10 percent in 1997, having fallen from 37 percent in 1980 and 17 percent in 1990 (World Bank 1997, 221). South Korean democracy has also revealed strong regional cleavages. These will be touched upon below, but they do not change the basic argument--that policy change under democracy has been driven by dispersed interest group preferences and political institutions.

7. This change was primarily motivated by a perception that the U.S. security com- mitment was weakening, and that South Korea would consequently have to become more militarily self-sufficient.

8. Labor organization and labor market regulation made it possible to segment chaebol labor markets from other labor markets. This meant that labor market competition was prevented from driving chaebol wages down to the level pre- vailing in local labor markets. As a result, rents are divided between labor and capital in the relevant privileged industries, rather than captured fully by capital.

9. Growth rates averaged 7.1 percent in 1989-93, as compared to 11.1 percent in 1983-88 and 12.6 percent in 1986-88.

10. The attempted imitation of Japan's hegemonic Liberal Democratic Party was clear to all.

11. These reforms began by purging politicized factions from the armed forces and the state administration, and blocking traditional avenues for illicit campaign contributions. They climaxed with the spectacular December 1995 trials of Chun Doo-hwan and Roh Tae-woo.

12. Workers could now be moved from non-striking plants to striking plants within the same company, and management no longer had to pay most striking workers (Oh 1999, 204-5).

13. Of course, there were much disagreement about the specifics of how to do so. The most vigorous opposition came from the chaebol themselves, from organized labor, and from regions with large concentrations of financially weak businesses.

14. In late 1999, however, a number of measures were passed to increase the effi- ciency and autonomy of state economic regulatory bodies.

.

5.

6.


15. Important non-economic issues also influenced the election outcomes. Kim Dae- jung received some additional support from his "sunshine policy" of engage- ment with North Korea. He was able to announce an unprecedented leadership summit just before the elections. On the other hand, he was hurt by corruption scandals involving NCNP/MDP figures, and by perceptions that his personnel policies favored Cholla and that state prosecutors abused their powers for parti- san political ends.

16. There were a complex of factors involved. In addition to investor uncertainty over incomplete reforms and anticipated political gridlock, rising oil prices and weakening international demand were also important factors.

17. Daewoo's founder, Kim Woo-chong, fled abroad rather than face prosecution for financial fraud and embezzlement.

18. Cholla is located in the country's southwest, Kyongsang in the southeast, and Chungchong in the "midwest."

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