Going for Broke
Korea steels itself against failure

Far East Economic Review
June 11, 1998

E ven a thick fog cannot disguise the awesome brawn of Korea's industrial arm. Here at a sprawling mill on Asan Bay, sparks fly amid the roar of heavy machinery as a helmeted worker waves into place an overhead crane bearing a huge vat of molten metal. Behind him a line of glowing red logs shows the next stage in a process that will ultimately transform the heaps of scrap resting outside into long iron bars of assorted thicknesses. Last year this mill produced 1 million tons of these bars. About the same is expected this year.

Only one problem this is Hanbo Steel. And it's supposed to be broke.

Hanbo Steel filed for bankruptcy in February 1997, but its continued production--and the lack of resolution about its fate--bespeaks a key structural flaw in many Asian economies an unwillingness to let businesses fail. Hanbo, of course, is a particularly notorious monument to the colossal ambitions of Korea, Inc., having built up a debt amounting to more than 22 times its equity. But the ill effects of Hanbo's managerial excesses have been exponentially compounded for all of Korean society by a structure that keeps bankrupt firms alive by exempting them from interest and principal repayments. The effect is to punish efficient companies by introducing unfair competition from the least efficient.

Nor is this a problem confined to Korea. Japan's economy continues to be weighed down by mountains of hidden bad debt. In Indonesia most companies stopped paying their dollar-denominated debt when the rupiah collapsed. And in China nearly 40% of all state-owned enterprises continue to operate in the red. With a few notable exceptions--Taiwan, Hong Kong and Singapore--in practice it is almost impossible for creditors in Asia to collect on assets, whatever the bankruptcy laws may be on paper. In this way the main benefit of bankruptcy is thwarted a market pricing that transfers assets from those who can't make a go of them to those who can.

In Korea, the reluctance to declare bankruptcy may be especially understandable, because in so doing the owner opens himself up to criminal liability. Again, the perverse incentive is for managers to keep shovelling good money after bad in a place with precious little of either. In the process it is the good who suffer. Thus the howls from rival steel makers, Korean no less than foreign, who have complained to a deaf Kim Dae Jung government that Hanbo's relief from its debt repayments is allowing it unfairly to undercut prices in already slow market.

A comparison with neighbouring Taiwan may help illustrate the point. On paper the two economies are strikingly similar front-line Cold War protectorates of the United States, dictatorships that turned to democracy in the 1980s, economies that compete in many of the same markets in metals, chemicals, textiles, electronics and chips. But whereas Korea's economy is dominated by the large and cumbersome, Taiwan's is lean and mean. It is hard not to believe that Taiwan's willingness to let its companies go belly up has something to do with its resiliency. In 1996, for example, some 25,272 companies went out of business, about 4.7% of the total. The comparable figure for Korea is less than a tenth of that.

In a recent productivity survey of Taiwanese manufacturing published by the U.S. National Bureau for Economic Research, authors Bee Yan Aw, Xiaomin Chen and Mark J. Roberts found that the ease of entry and exit in Taiwan helped boost productivity by "facilitating the transfer of resources from the less to more efficient producers." Even more remarkable is how rapidly the new market entrants come to dominate their sectors. In 1991, for example, 38% of textiles and 54.2% of fabricated metals in Taiwan were produced by companies that didn't even exist five years before.

Understandably there are typically compelling human reasons why bureaucrats may decide to maintain companies. Here at Hanbo, for example, the company has halved its workforce. In addition, it is generally necessary to maintain a certain degree of operation to keep machinery operational. But the longer the final reckoning is delayed, the longer capital is tied up in unproductive (and in Korea's case, counterproductive) uses. It is certainly possible to keep a failing company alive with special assistance, maybe even to the point where it gets back on its feet. But Hanbo Steel should remind us that those who would intervene to save an inefficient company may inadvertently be condemning a healthy one.

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June 6, 1998