The Reformers

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lowing his upset election victory in December, South Korean President Roh Moo Hyun was a guest speaker at an élite gathering of the country's captains of industry. It was an introduction of sorts. Roh, a crusading human-rights lawyer who washed into office on a wave of anti-establishment sentiment among young voters, is a political outsider virtually unknown to the influential tycoons who traditionally had close ties to the top leadership. Roh's campaign was financed without contributions from Big Business, according to an official at the President's office, and as Roh spoke he implied that his presidency wasn't in anyone's pocket. "Isn't it good," he asked his audience coyly, "that political parties didn't ask you for money?"

Executives were on notice: a reform blitz was coming. Last week it began when South Korea's Fair Trade Commission launched a broad-ranging investigation into the country's flagship industrial groups?the chaebols?in an attempt to crack down on illegal transfers of money and assets among affiliated companies. Businesses named in the investigation include the Samsung group, a budding consumer-electronics giant and the world's largest memory-chip maker; LG group, a power in electronics and chemicals; and Hyundai Motor Co., the country's largest carmaker.

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The probe sent a shudder through Seoul's boardrooms. It comes just weeks after Chey Tae Won, nephew of the founder of the SK group, the third largest chaebol, was put behind bars for alleged illegal share transactions aimed at strengthening his control of the group. "This is a warning to other chaebols," says an executive. "You get out of line, and we throw you in jail." Businessmen are not only worried about the threat of arrest. The cleanup drive comes at an unsteady time for Korea's fast-growing economy. Soaring oil prices, slowing domestic consumer spending and sputtering U.S. recovery are all taking the steam out of GDP growth that last year was a robust 6%. Adding to the uncertainty is the North Korean nuclear crisis, replete with the Dear Leader's market-rattling taunts. At the Sabi clothing shop in central Seoul, owner Kim Na Young says sales of her handmade jackets, vests and shirts have plummeted by two-thirds since November because the crisis "is scaring away customers."

Conservative economists say Roh's full-court press against chaebols will only make matters worse by frightening investors and harassing some of commerce's leading lights. Members of Roh's inner circle "look like zealots and ideologues, not policymakers," complains Kim Jong Seok, an economist at Hong Ik University in Seoul and an adviser to Roh's conservative opponent in the presidential race. The family-run chaebols?sprawling mini empires of affiliated manufacturers, suppliers, distributors and other companies?dominate key sectors of the economy, including insurance and electronics. Samsung's high-tech affiliate, Samsung Electronics, alone shipped 14.5% of Korea's exports last year; its market capitalization makes up 18% of the total value of the South Korean stock market.

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South Korea has been swept by reform fever before. After the 1997 financial crisis, momentum mounted to purge some of the conglomerates' abusive business practices and reduce their monopoly-like grip. The previous administration of President Kim Dae Jung made progress by arm-twisting the chaebols into paring debt and divesting loss-making affiliates. The country's most debt-ridden basket cases?such as the Daewoo group, once the country's second largest company?have been dismantled.

But the reform effort under Kim ran out of steam, leaving many plans undone. Roh wants to finish the job. Reformers argue that making the chaebols more transparent and accountable will end the so-called "Korea discount" investors apply when evaluating Korean companies. Says Kim Jin Pyo, Roh's newly appointed Finance Minister: "Reforms will play the role of engine of growth."

The case against SK's Chey shows the type of byzantine insider deals Roh wants to stamp out. Chey is accused of illegally manipulating shares of several SK affiliates in a series of stock swaps that cost shareholders more than $170 million. In one case, he reportedly traded shares he owned in a hotel to an SK group software company at a vastly inflated price. Ultimately, the financial maneuvers made him SK Corp.'s largest shareholder and solidified his control over the entire group, which includes Korea's largest mobile-phone service provider, SK Telecom. An SK spokesman said the group is cooperating with the investigation.

In addition to the newly launched investigation, Roh's aides are planning other remedies, such as legalization of shareholder class action and closing tax-law loopholes that allow founding families to transfer assets to relatives while dodging inheritance taxes. The reform drive in the short run "will lead to an increased sense of uncertainty" among investors, says James Paterson, director of research at brokerage firm CLSA Emerging Markets in Seoul. But the majority of Koreans seem to support the effort. South Korean business confidence rose to a five-month high in February, according to a survey by the Federation of Korean Industries, on expectations that the Roh administration would be good for investment and business in general. In the end, says Paterson, "you'll see a healthier and more transparent Korea."

For now, though, the health of the economy depends more upon factors that have little to do with the chaebols. Consumer spending, which thanks to tax breaks on credit-card debt helped power economic growth in the past several years, looks tapped out. Household debt jumped 28.5% last year, and financial companies are scaling back on lending. The highest oil prices in decades will take a big bite out of an economy almost entirely dependent on imported energy, hitting the petrochemical industry especially hard. Increased costs associated with imported oil resulted in the country running a trade deficit in January and February?the first back-to-back months of deficit since the 1997 financial crisis. Economists project South Korea's GDP growth will drop to about 4% in 2003, one-third lower than last year's rate.

And then there is the great intangible?the North Korean nuclear crisis, which has contributed to an 18% drop in South Korea's stock market since January. Rating agency Moody's Investors Service last month warned that the South Korean government could face a downgrade of its credit rating if tension on the peninsula continues to worsen. That would increase interest rates and borrowing costs, damping corporate profits. Says James Rooney, chief executive of financial consultancy Market Force in Seoul: "Investors are just looking at the North Korea game escalating another notch, another notch, another notch. They're starting to ask themselves if it's safe to be here anymore." Now that Roh's reform campaign is under way, that's also a question a few chaebol executives may be asking themselves.