The Chill Wind of Korean Xenophobia
by Kim Wan-soon and Lee You-ll
Far East Economic Review
December 2005

WHEN FINANCIAL CRISIS struck South Korea in 1997, many observers foresaw at least one "blessing in disguise." The external shock forced the country to abandon its insular and protectionist stance and embrace whole-heartedly a FDI-driven globalization process. And indeed the Foreign Investment Promotion Act of 1998 did mark a dramatic change in policy toward inward investment.
 
However, a recent spate of grievance cases brought by foreign companies has cast serious doubt on Korea's commitment to globalization and FDI liberalization. Korean public sentiment has turned against foreign capital due to the growing presence of foreign-controlled banks and the entry of foreign equity funds. Korea is widely perceived as reverting to its old "hermit kingdom" mind set.
 
Last month, we completed a survey of 43 CEOs of foreign companies doing business in Korea and heads of foreign chambers of commerce in the country, asking them about their perceptions of the business climate for inward investment. Their answers confirmed that they are feeling the chill wind of xenophobic attitudes making a comeback. But the picture was hardly one-dimensional, as other problems also affected their calculations. Moreover, most of those interviewed remained optimistic about business prospects, and noted that Korean ambitions to make the country into a regional hub for international companies will require further liberalization.

A Battlefield Conversion

WHEN FORMER PRESIDENT Kim Dae Jung took office on Feb. 25, 1998, the new administration inherited a shattered economy. Fortunately, he also had a mandate to carry out massive structural reforms required by the International Monetary Fund as part of the $58.4 billion rescue package. One of the top priorities of the new administration was attracting FDI in order to overcome the currency crisis and strengthen the competitiveness of Korean industry.

Prior to this, FDI played an insignificant role in Korea's economic development. In the initial period of Korea's modern economic growth during the 1960s, foreign capital inflows were encouraged to make up for the shortage of domestic savings and foreign reserves. However, the Korean government preferred foreign borrowing, which brought foreign resources under its control, as opposed to FDI.

That's because the government and the public feared that Korean industry would be dominated by foreign entities, a deeply rooted sentiment due to the recent history of Japanese colonization from 1910-45. Even today there is a lingering suspicion that FDI is really just a means for foreigners to control the Korean economy. Another factor working against FDI was the relative cost structure of capital--in times of inflation and exorbitantly high domestic interest rates, cheaper borrowing from accessible offshore markets was much more attractive to Korean businessmen than foreign equity capital.

Only after teetering on the brink of default in late December 1997 did Korea realize that foreign borrowing carried substantial hazards and that FDI could act as an important stabilizer against the risk of financial panic. The Foreign Investment Promotion Act legally and unconditionally guaranteed international remittances by foreign investors, and more importantly focused on creating an investor-friendly environment through the introduction of various support measures, including a wide range of financial incentives, as well as the establishment of institutional vehicles, such as the investment ombudsman system.

With the passage of FIPA, Korea's FDI regime has been effectively liberalized, with 98.2% of all business sectors open to foreign investment, on par with other OECD economies. Also, the amendment to the Foreigner's Land Acquisition Act in May 1998 saw restrictions on foreign ownership of land, property and dwellings completely removed. As a result, the amount of land acquisition by non-Koreans climbed 3.9-fold to 148.5 million square meters from 1997 to 2003.

The combination of sweeping liberalization measures and pro-FDI institutional reforms designed to lure foreign investors has enabled Korea to record a dramatic increase in inward FDI since 1997. Total FDI during the past seven years alone (1998­2004) tallied more than $79 billion on a notification basis, which is nearly quadruple the $25 billion posted during the previous 35 years.

This recitation of Korea's FDI successes is not meant to disguise the fact that reform has not proceeded in an entirely trouble-free fashion. It is widely acknowledged that Korea has been slow in implementing restructuring in its financial, corporate, labor and government sectors, due to the painful decisions that must be made along the road toward conforming to global standards. As inefficient businesses and public enterprises are allowed to go bankrupt, or are restructured or privatized, widespread layoffs and unemployment cannot be avoided.

Labor Unrest

ONE KEY ASPECT of the Korean working environment that foreign companies must come to grips with is that of the confrontational relations between labor unions and management. Apart from more general deterrents to FDI, the Korean labor market is the single most consistent worry for foreign MNCS. Many interviewees and foreign chambers of commerce believe that Korean labor law disadvantages management. Before the labor reform drive of 1997, Korean labor policies had provided excessive employment protection and wages had grown too rapidly due to the influence of labor unions. It is for this reason that management insisted that a flexible labor market was a prerequisite to enhancing the global competitiveness of domestic firms and luring FDI.

Labor-management discord at foreign­invested companies was the most damag­ing economy-related issue in 2003, as evidenced by strikes at companies such as Owens Corning Korea, KGI Securities, Tetra Pak and Nestle Korea, among others. Although Korea's unionization rate of 11% is significantly lower than many other OECD economies, the labor unions can mobilize 89% of less privileged employees. In 2003, there were 32 labor disputes reported at foreign-invested companies, compared to 26 cases a year earlier. Of the 32 cases investigated by the office of Investment ombudsman located at the Korea Trade­Investment Agency, 16 were in the auto­parts sector, showing that disputes mainly took place in the labor-intensive sectors. Of course, the vast majority of foreign-invested firms have never experienced labor-management conflicts, particularly in the high-tech and capital-intensive lines.

Aside from union militancy, rising labor costs have been one of the major reasons for the slowdown in FDI into Korea, as multinationals relocate their manufacturing operations to cheaper countries. According to the U.S. Bureau of Labor Statistics, average hourly compensation costs in U.S. dollars for Korean production workers in manufacturing increased by 17.3% in 2003 to $9.16. In terms of labor unit costs, defined as the cost of labor compensation per unit of output, the figure for Korea rose by 6.6% between 2001 and 2002 because wage costs grew faster than labor productivity.

Bringing labor laws and institutions in line with global standards while minimizing social costs stemming from labor-management conflicts is certainly one of the key tasks to be addressed if Korea hopes to join the ranks of mature industrialized countries. It is quite encouraging in this context to note that the OECD favorably reviews Korea's Roadmap for Industrial Relations Reform. In line with the OECD recommendations, Korea has committed to revise its labor laws and industrial relations systems to meet global standards by 2007.

Excessive Regulation

THE MOST COMMON complaints from the foreign business community in Korea relate to inconsistent and obscure laws and policies formulated at the discretion of various government organizations. Korean legislation is plagued by many vague expressions such as "adequate," "suitable" or "other similar cases." Government organizations therefore have huge discretionary powers when implementing the law, and this power is often exercised improperly.

Foreign businesspeople do have legitimate complaints. First, Korean civil servants have a reputation for possessing an inflexible and uncompromising mind set. This stems from the conservative atmosphere within the bureaucracy and the current civil service examination system, which relies on rote memorization of arcane regulations rather than sufficient testing of analytical and reasoning skills. This effectively bars bright and creative individuals, especially those educated abroad, from entering the civil service since they tend not to spend their time memorizing the relevant rules and regulations.

Second, the civil service does not conduct adequate surveys and in-depth evaluations to keep abreast of recent changes in the economy and current market conditions. While the market has experienced turbulent and rapid changes, such as revolutionary technological breakthroughs, emergence of new management skills, etc., corresponding progress within Korea's bureaucratic organizations has not taken shape.

Perhaps most frustrating is the inconsistent interpretation and application of conflicting regulations among the various government agencies at all levels. This undermines smooth and effective administration, hampers clear communication with related parties, and leads to unnecessary requests for information. For example, many foreign companies interested in setting up large discount stores in Korea are in for a rude awakening when it comes to applying for a building permit. After spending much time and energy trying to find their way through the bureaucratic jungle, foreign companies, exasperated and frustrated by this time, often find themselves at the mercy of local politicians.

Opening the "Hermit Kingdom"

PREJUDICE AGAINST FOREIGN companies and the associated fears of imperialism are still the main obstacles to attracting FDI into Korea, according to the majority of our interviewees. Although the lingering suspicion of FDI held by many Koreans has slowly eroded with the growing recognition that FDI has played a vital role in helping to revitalize the Korean economy following the financial crisis of 1997, there have been periodic outbreaks of anti-foreign sentiment. It can be said that curbing xenophobic sentiments and fostering an open society is the most difficult yet perhaps most fundamental task for the globalization of the Korean economy.

Several cases elucidate the closed mind set of the Korean people. Although it is common knowledge that Korea has a highly trade-dependent economic structure, it took seven months of deliberations and three failed attempts for the National Assembly to ratify a free-trade pact with Chile, the first such agreement ever entered into by Korea with another country, because of the overzealous and nationalistic agrarian interest groups.

The bilateral investment treaty between Korea and the U.S., expected to rejuvenate sagging FDI inflows to Korea, has been indefinitely postponed because of the interests of a relatively small number of movie industry lobbyists who are fervently opposed to relaxing the country's screen quota system. Furthermore, the Bank of Korea has contended that the presence of foreign financial institutions in Korea is a destabilizing factor in the Korean economy.

Misleading, emotional appeals, which are devoid of any logical substance and recklessly cite the outflow of national wealth argument, fail to recognize that foreign-invested firms bring advanced technology and management know-how into Korea, thereby producing healthy competition, promoting corporate transparency and raising overall productivity.

Northeast Asia's Business Hub?

FEW WOULD DENY that the Korean econo­my is increasingly caught between China's cheap labor and Japan's technological prowess. As a Booz, Allen and Hamilton re­port in 1997 put it, Korea risks being "nutcrackered" by its two giant neighbors. Fortunately, the country is waking up to the fact that it may have no choice but to make a drastic move to chart a new course for the 21st century in order to adjust to the changing regional economic dynamics of Northeast Asia and to prosper despite its limited natural resources. Against this background, Korea unveiled in July 2002 a detailed plan to transform itself into a world-class logistics center, a knowledge-based economy, as well as an international business and financial hub of Northeast Asia.

The business hub idea was initially focused on creating a logistics hub, but has since been extended to include visions of Korea as a center for finance, R&D, and regional headquarters of multinationals. A core task for becoming a Northeast Asian business hub, from an operational perspective, is the designation of free economic zones. According to the Act on the Designation and Management of Free Economic Zones, which went into effect in July 2003, three areas in Incheon were designated as the first FEZ on August 2003. The Incheon FEZ  triangle plans to be home to logistics and business centers, high-tech knowledge-based industries, a financial center, and leisure/tourism complexes by the year 2020. For the financing of these ambitious projects, the total required outlay is estimated to reach a staggering 202 trillion won (about $174 billion). What should be noted, however, is that the share of FDI is projected to be only about 10% ($17.6 billion), much less than in Shanghai, which has an overwhelmingly large foreign financing component. Subsequently, Busan/Jinhae and the Gwangyangman Bay area were designated as the second and third FEZs, respectively, in October 2003.

FEZs are thus preparing to offer various tax incentives, one-stop administrative services, and improved housing, education and medical services to foreign investors. In addition, FEZs will utilize English for all administrative paperwork and will allow for the unlimited use of foreign currency. Furthermore, the government has announced a plan to relax many of the rigid labor regulation within FEZs, such as mandatory employment requirements for veterans, the disabled or the elderly, that have long burdened foreign firms operating in Korea.

Despite the Korean government's and the media's promotional efforts, however, the majority of foreign companies in Korea remain skeptical of the government's ambitious vision. Ironically, these companies remain overwhelmingly positive about their own prospects in Korea. Nevertheless, this can't obscure the fact that Korea's is losing its competitiveness in attracting FDI compared to its rivals. Korea's brand image and business environment, reflected in the interviews, are far less competitive than other major cities of Asia.

For instance, a 2002 survey of 1,700 managers at 71 Fortune 500 companies in Asia showed that Seoul came in last after Hong Kong, Shanghai, Singapore and Tokyo in five of eight categories: globalization status, foreign-exchange controls, labor market flexibility, work permits, immigration, and prestige. In a similar vein, a McKinsey report released in July 2003 found that Seoul must overcome many significant barriers if it is to become a financial center in Northeast Asia, including its restrictive and anti-market regulatory practices, lack of English language abilities, disruptive unions, and comparatively inconvenient living conditions for foreigners.

THE PREVAILING PERCEPTIONS are that Korea is saddled with chronic inefficiency, inconsistency, unpredictability and hidden inter­pretations in its FDI policies, unequal treatment in the domestic market, and relatively higher political and social instability than in other Asian countries. Any or all of these shortcomings could certainly stifle Korea's globalization strategy aimed at attracting major multinational businesses.

To sum up, the most significant finding of our study is that despite Korea's remarkable crisis recovery and financial stabilization, FDI policies and the government's behavior toward foreign investment are still viewed as inconsistent and unpredictable, "xenophobic" or even "schizophrenic" by many in the international business community.

The liberalization measures adopted during the financial crisis have failed so far to show results in terms of a global outlook. Without a commitment to changing the closed mind set at the grass-roots level, institutional reforms are doomed to be short lived. For the government to maintain the momentum toward globalization, it must show strong leadership in demonstrating the benefits of an open and market-driven economy, and educate and enlighten the public.

- Mr. Kim was ombudsman of the Korea Trade­Investment Promotion Agency from 1999-2005. Mr. Lee is a senior lecturer of international business at Edith Cowan University, Australia.