Economic Reform and Business Opportunities in Korea

Economic Reform and Business Opportunities in Korea

Governor You Jong-Keun _*

New York, September 25, 1998

Ladies and gentlemen, and distinguished guests! First, I would like to thank you for your continued interest in Korea and our ongoing efforts to get our economy back on the track of economic growth and prosperity. United States is the number one trade partner to Korea and American firms have made significant contributions to the recovery not only in Korea but throughout the Asia-Pacific region. I have come here today to encourage your further participation in the recovery of the Korean economy by briefing you on Economic Reforms and Business Opportunities in Korea.

1. Risk and Reality

It has now been over a year since the financial crisis first swept across the Asia-Pacific region, bringing with it the whirlwind of economic instability and uncertainty that has since spread across global markets. For investors, the question of how and when the crisis will affect their investments has only added to the sense of urgency and sent many in search of so-called financial " safe havens."

In Korea, the answers came swiftly and painfully back in November of 1997 when the country was forced to turn to the IMF for a US$58 billion economic rescue package. The ramifications of this crisis have been profound, both in terms of investor confidence and direct investment in Korea. Through 1998, foreign investors remain wary of assuming the risk in an economy in which they saw 1 in 10 businesses go bankrupt through the first half of the year.

But, as all investors are keenly aware, nothing is won without risk. Are there risks to investing in Korea? Yes. Are those risks manageable and foreseeable? Absolutely. Our world is one undergoing fundamental change. From the globalization of world markets to the technological innovations transforming the way we live and do business, risk and change may be the only constants.

But despite their unwanted effects, I do believe that the consequences of these changes are positive on balance. I also believe that Korea is uniquely positioned to benefit from, and capitalize on these changes to emerge as a fundamentally stronger, sounder nation. So for the investor with true foresight, I say that Korea is, in fact, the diamond in Asia's economic rough.

The basis for my beliefs is rooted in the sweeping reforms now being instituted by the administration of President Kim Dae-jung. In a crucial break from the past, Korea now adheres to the principles of an open and free market system and is committed to promoting increased competition and fair play. Recent events in some Asian countries have raised speculation about the possibility of a return interventionism. But in Korea, it will our country's commitment to reform and the free market, not the economic machinations of government, that will lead the return to economic growth, and usher in a new era of democracy and prosperity.

But now, let me discuss what the Korean government is currently doing to reform the economy, and how these reforms will provide new business opportunities for foreign investors in Korea.

2. Progress of Current Reforms

Over the last thirty years or so, the remarkable growth of the Korean economy has largely owed to an export-driven economic development plan, managed by a tightly interconnected circle of government, banks and big business. The system worked so well, in fact, that investors once labeled the country, " Korea Inc." But late last year, Korea received its reality check--and the bill was in excess of $150 billion.

Bringing an end to the old ways of " Korea Inc." first means the elimination of the corrupt and collusive links between the government, banks and the country's giant, debt-financed conglomerates, known as the chaebol. By holding itself wholly accountable to the people, the new administration is setting the example for reform. But in order to truly change the system, we also need fundamental changes in the behavior of a highly entrenched corporate bureaucracy as well as Korea's famously unwieldy labor unions. These are formidable tasks, and have forced Korea to not only change its paradigm for political and economic management, but also the basic rules of the economic game.

First and foremost, Korea is redefining the role of the government. In its previous stage of development, Korea believed that the government could complement the functioning of the free market. In reality, however, the government ruled over the market with an arbitrary hand, protected big business with various entry and exit barriers, and blocked both the free flow of foreign capital as well as foreign goods and services into the economy. But today, the role of the government is being dramatically reduced. Bloated bureaucracies are being streamlined; deregulation is being pursued vigorously; and government-invested companies are to be privatized. By the end of the year, the number of regulations affecting economic activity is expected to be reduced by half.

Secondly, Korea is taking steps to bring both accounting methods and management transparency up to internationally recognized standards. For investors, the lack of transparency remains one of the major stumbling blocks to investing in Korea. But now, the era of unaccountable management is over. In the private sector, directors now find themselves legally accountable for the management of their firms, as government-led measures continue to strengthen the rights and voices of minority shareholders. To improve financial management and accounting, the government will make consolidated financial statements mandatory and prohibit cross-debt guarantees at the country's largest business groups. These efforts are all part of the government's drive to establish fair and transparent " rules of the game, " to level the playing field for all the players in the Korean market.

3. Foreign Investment--An Engine for Growth

As we all know, reform is not built in a day nor completed in one giant step. It must be a steadfast and continuous process. And in the case of Korea's current reforms, foreign investment will play a greater role than ever before.

Investment advisors are fond of saying " foreign investment cannot be arranged; it must be fought for." The fight in Korea will not only be to attract foreign investment, but to put an end to a system that nurtured monopoly and oligopoly at the expense of free and fair competition. In line with their major restructuring programs, Korean companies must look to form strategic, synergistic alliances with foreign firms that combine their experience and know-how with the technological and creative strengths of their foreign counterparts. These alliances, such as those between GE and Korean Air, Bell Canada International and Hansol PCS, or the $1 billion joint venture between Abitibi Incorporated and Hansol Pulp & Paper, are good examples of how the companies involved can promote mutual benefits, and boost their regional and international market presences.

Why Korea? While skeptics of Korea's prospects for economic recovery continue to dwell on the negative, allow me to shed some light on what has been, and will be, done to return the country to the economic fore and to prepare its workers and companies to compete in the coming 21st century economy.

First, let me discuss Korea's controversial labor situation. The skeptics will say that Korean unions are and will remain steadfastly militant. But the reality is that the labor environment in Korea is undergoing very real and permanent change. In February, the Tripartite Commission of government, labor and management signed the landmark resolution on layoffs that paved the way for comprehensive labor market reform. And while public acceptance maybe slow, the recognition of their necessity grows daily. In the much maligned Hyundai Motors strike settlement, the company managed to pare down employment by more than ten thousand, in spite of the fact that the number of formal layoffs was reduced to 277.

And in order to help ease the pain of this transition, the government is now building Korea's first true social safety net. Indeed, past governments lacked the foresight to see beyond the years of double-digit growth and lifetime employment. But now, with unemployment rolls exceeding 7% of the labor force, the government has pledged to aid those displaced during the crisis while working to create a healthier, stronger economy and, ultimately, new and better jobs and opportunities for everyone.

Secondly, Korea continues to have a sizable domestic economy. Before the crisis it was the eleventh largest economy in the world and it remains an economy with a large component of domestic demand. Korea is also a neighbor to the world's second-largest economy in Japan and the world's fastest growing market in China. With such strategic location, foreign investors in Korea will not only get one of the most economically profitable and politically convenient" windows on the world, " but also an ideal place to base their Asia-Pacific operations.

In addition to a strong workforce, Korea also boats a well-developed industrial base that can complement the operations of foreign investors. Korea is home to many industrial parts and components companies, a large steel production sector, and a well-developed and efficient construction industry. By combining themselves with companies in these sectors, foreign investors can increase their presence throughout the region and boost their competitiveness throughout the world.

Koreans, in both the public and private sectors, now welcome foreign investment with open arms. Korean firms are serious in their desire to develop harmonious relations with foreign firms and have much such efforts a key part of their respective restructuring programs. They recognize the fact that foreign capital can and will play an important role in the recovery of the economy, and are actively seeking foreign partners in a number of fields including manufacturing, services, and real estate management.

The government is also going to great lengths to facilitate this process. The Korea Investment Service Center has been established to assist foreign investors by providing advice on everything from tax breaks to financial incentives, and assists foreign firms with their search to find and purchase business locations. In addition, the government has recently enacted Foreign Investment Promotion Act to remove obstacles to foreign investors and provide additional tax exemptions.

4. Korea: Towards a Brighter Future

The Korean government's efforts to overcome the current economic difficulties have already started to bear fruit. More than anything else, the foreign exchange market has made a remarkable turnaround, and remained relatively stable, even in the midst of the recent worldwide instability. Usable foreign reserves, which stood at $3.8 billion on the day Kim Dae-jung was elected President last December, have topped $43 billion as of middle of September, partly boosted by a record current account surplus that reached $25.5 billion through the end of July. In addition, stability in the foreign exchange market has allowed a significant reduction in interest rates. For example, measured by the yield on the 3-year corporate bond, the benchmark rate has come down from 30% several months ago to well below 13% today.

Inward foreign direct investment has been almost restored to its pre-crisis level, totalling $4.1 billion from January to August of this year. A number of deals have already been closed, including the US$260 million investment by BCI and AIG in Hansol PCS; Bowater Paper Corporation's purchase of paper production operations from the Halla Group for $240 million; U.S.-based Motorola Corporation's announcement of a planned $300 million increase in its investment in Korea; the purchase of Samsung Heavy Industries construction equipment manufacturing division by Sweden's Volvo Corporation; and Germany's BASF AG, which has acquired several divisions of Korean manufacturers, including its US$600 million acquisition of Daesang's lysine unit.

Despite this progress, Korea still has many difficulties to overcome. In the second quarter of this year, GDP growth contracted at an annual rate of 6.6%, while unemployment figures soared to 7.6% of the total labor force, or 1.65 million people in July. At financial institutions, pressure to improve their own financial situation in addition to increased market risk have forced them to strictly curtail lending, thus exacerbating an already severe credit crunch. Recently, the Korean government decided to take expansionary measures to prevent a further deterioration of the Korean economy. These measures are intended to provide a favorable environment for the reform process and are being taken in close consultation with the IMF.

5. Conclusion

In The Road to Serfdom (1944), the Nobel laureate F.A. Hayek said that " If we are to build a better world, we must have the courage to make a new start." In Korea, that new start has begun under the leadership of President Kim Dae-jung. In his national address to celebrate the Republic of Korea's 50th Anniversary, he urged the Korean people to come together to overcome the current economic crisis and help build a new era of democracy and prosperity in our country.

To do so, he said, " Koreans must be resolute in their commitment to economic restructuring and comprehensive national reform." The Korean people and government have a clear understanding that there is no way out, except to continue reform. The prudent investor weights risk against benefit. As prudent investors, I believe you will all recognize the great potential that lies waiting to be realized in Korea. Thank you.

Endnotes

* You Jong-Keun is Governor and Economic Advisor to the President (Korea) Back.