HCI investment coordination

Toward the end of the 1970s, increasing overcapacity and worsening profitably in HCIs posed serious challenges to policymakers. The government initiated three rounds of “investment coordination” in 1979 and 1980 and completed them by 1983.

The first round, started in May 1979 following the Comprehensive Economic Stabilization Program, was delayed during the change in governments and then resumed in August 1980 by the new administration. The government declared the investment coordination of nine companies in three industries (power generation, automobile and construction machinery).

In October, the second round of restructuring was imposed on three more industries (heavy electrical instruments, electronic switchboard and copper smelting). The restructuring continued in the 1980s with some modifications (Choong Yong Ahn and Joo-Hoon Kim, 1995, p.333; Economic Planning Board, 1994, pp.151-152). The government provided rescue packages, including loans from state-controlled banks, to troubled companies being restructured.

Despite government-led restructuring, HCIs continued to have difficulties up to the mid-1980s. The restructuring also accelerated the concentration of economic power and strengthened the monopolistic market structure. Most importantly, it failed to eliminate excess capacity, and “industrial rationalization” became necessary in the mid-1980s.

In 1985, to carry out rationalization in a systematic way, the government revised the Tax Reduction and Exemption Regulation Act (TRERA), abolished the promotion laws for individual industries, and introduced the Manufacturing Development Act (MDA). TRERA provided various tax benefits (such as the exemption from capital gains taxes) to companies subject to rationalization, and MDA enabled the government to regulate market entry and investment in rationalized industries.

Rationalization based on TRERA was carried out in many industries. Before 1985, it covered not only HCIs such as fertilizer, heavy machinery, power generator manufacturing and LPG importing, but also the shipping industry, which faced serious difficulties in the early 1980s. After 1985, the rationalization of power generator manufacturing and shipping industries continued, while overseas construction, coal mining and shipbuilding industries were added to the list. At the same time, the government restructured 78 troubled companies in 1986 and 1988 in five rounds (Joon-kyung Kim, 1991, p.46).

Rationalization based on MDA began in seven industries (automobile, construction machinery, diesel engine, electrical instrument, alloyed metal, textiles and dyeing) in July 1986. Fertilizer (December 1987) and footwear (February 1992) were added later. In these industries, new market entry was restricted during the rationalization period and financial support was given to existing companies. Most of the rationalization was completed by 1988-1990.

Investment coordination and industrial rationalization depended on strong anti-competitive measures such as creating monopolies and banning new market entries. Table 2-10 illustrates the case of automobile manufacturing. The government also provided financial support and tax benefits. For the insolvent firms restructured in 1986-1988, all liabilities in excess of assets were to be eliminated. Debts of 986.3 billion won were written off, the repayment of another 1,640.6 billion won was postponed, and interest payments on 4,194.7 billion won were either postponed or reduced. New long-term lending of 460.8billion won was also provided at a low interest rate. Furthermore, companies received total tax benefits of 241.4 billion won. To compensate for the losses incurred by commercial banks, the BOK granted to six banks special loans of 1,722.1 billion won (299.9 billion won in 1985, 684.4 billion won in 1986 and 773.8 billion won in 1987) at an interest rate of three percent (Joon-kyung Kim, 1991, p.47). This amount was equivalent to 53.5 percent of the net increase in the reserve base between 1984 and 1987.

Table 2-10. Investment coordination and industrial rationalization in automobile manufacturing

One may argue that the government had to initiate restructuring because it was responsible for the failure of companies that participated in the HCI drive. This explanation is incomplete, however, because the government also tried to rescue companies in such industries as shipping, overseas construction and textiles that were not part of the HCI drive. Amore important reason for government intervention must have been the fear that acorporate and banking sector breakdown¹⁾ would generate an economic crisis.

The intervention succeeded in averting a crisis in the short term by propping up failed companies, but hampered long-term stability by dodging painful restructuring and increasing moral hazard in the corporate and banking sector. The risk partnership between the state and the private sector was strengthened in the 1980s. Private sector-led growth as emphasized by the government did not materialize. If the government had let insolvent firms fail in the 1980s, the growth of corporate debts and non-performing loans held by banks after that would have been much smaller and the impact of the 1997 crisis much milder. It should also be noted that the chaebol increased their size in the process of restructuring and rationalization.

Source : SaKong, Il and Koh, Youngsun, 2010. The Korean Economy Six Decades of Growth and Development. Seoul: Korea Development Institute.

NOTE

¹⁾ Yeong-hyo Park (1985) claims that as of October 1985, non-performing loans (NPLs) held by banks amounted to 4 trillion won, or 14.5 percent of their total lending. Similarly, Choong Yong Ahn (1986) reports an NPL estimate of over 5 trillion won in November 1985.

References

· Ahn, Choong Yong and Joo-Hoon Kim, “The Outward-looking Trade Policy and the Industrial Development,”in Dong-Se Cha and Kwang Suk Kim (eds.), The Korean Economy 1945-1995: Performance and Vision for the 21st Century, Korea Development Institute, 1995, pp.312-369 (in Korean).
· Economic Planning Board, Thirty-year History of the Economic Planning Board Ⅱ (1981-1992): Economic Policies in the Liberalization Era, 1994 (in Korean).
· Kim, Joon-kyung, “A Study on the Disposal of Impaired Assets of Banks,”Korea Development Review, Vol. 13, No. 1, 1991, pp.35-63 (in Korean).