[Seri column]Don’t count the jaebeol out

Many Koreans say that when they are abroad, they feel more pride in the brand names of Korean global firms than they are about being Korean. But they may scorn their source of pride, the jaebeol, claiming the family-owned business groups wield far too much economic power and should be regulated more.

While no one can claim that the jaebeol system is perfect, it would be instructive to consider the comparative advantages that it enjoys over Korea’s neighbors.

We find the core of the jaebeol system is stronger than the keiretsu system of Japan, which also features a sprawling conglomerate structure. Compared to typical Taiwanese firms, jaebeol units are larger, and in contrast to the large state-owned enterprises that represent the face of corporate China, jaebeol do not face direct government control.

The result has been a system that has played three important roles in helping lead Korea’s economic development: 1) acting as an internal factor market; 2) sharing the risks of large and long-term investments; and 3) creating an efficient vertical integration structure.

In the period from the 1960s to the 1980s, during the early stage of Korean economic development, no well-organized market existed here. That is, labor, capital and product markets were so underdeveloped that business activity was constrained. At the time, the jaebeol system acted as a substitute market, or an internal factor market.

Certainly the jaebeol benefited from government support during that era, including directives to ease bank lending to the business groups. However, the jaebeol system also helped maximize returns on the loans by sharing profits generated among their affiliate companies.

The governance structure of the jaebeol system, in which there was a single headquarters for all of the family firms, made it possible for these firms to borrow funds within the conglomerate easily. This paved the way for various business group units to step up to the next level of development without the burden of seeking funds. Similarly, the jaebeol system efficiently filled labor needs with affiliates sharing or transferring personnel as needed.

From a macro perspective, these internal capital and labor markets in the jaebeol system were very beneficial to the rapid growth of the Korean economy, particularly during its early take-off stage.

Some scholars studying business groups in developing economies, including M. Guillen, a professor at the Wharton School of the University of Pennsylvania, have presented theoretical and empirical evidence to support this internal market view.

Secondly, during the 1990s, when Korean firms struggled with the new era of globalization, the risk-sharing structure of the jaebeol system allowed affiliates to spend heavily on research and development and product branding, which allowed these firms to catch up to leading firms in the global market.

Many researchers agree that if the Samsung Group had lacked such a risk-sharing system, Samsung Electronics could not have become the biggest player in the DRAM segment of semiconductors. Samsung Electronics was able to invest heavily in DRAM development and cover start-up losses thanks to the support of its sister companies. Additionally, cooperative development and the use of sales networks in foreign markets, despite scant information and experience, were very helpful in allowing jaebeol firms to achieve rapid growth overseas.

Third, the jaebeol system can provide member firms with greater efficiency through a well-organized vertically integrated production system among member firms. For example, several family firms of Samsung Electronics, such as Samsung Electro-Mechanics, supply high-quality, customized parts very efficiently to Samsung Electronics. Likewise, Hyundai Mobis, a group affiliate of Hyundai Motor Group, plays the same role as Samsung Electro-Mechanics. The relationships among sister companies are one of the main comparative advantages of jaebeol firms in Korea.

In addition, parts manufacturing companies can undertake risky long-term investments for technological development based on the stable demand of sister firms. As a result, favorable co-evolution among jaebeol has produced enormous benefits.

In some industries, such as the electronic or shipbuilding industries, Korean firms have already caught up with Japanese firms based on several performance measures, including productivity, and are becoming global leaders.

There have been persistent complaints of inefficiencies among jaebeol such as diversification outside core competencies. However, we cannot disregard the enormous impact of the jaebeol system on the take-off of the Korean economy. Likewise, the potential impact of jaebeol on the economic future of Korea should not be disregarded.

Jaebeol firms certainly have made positive contributions. Before criticism is heaped on any business-friendly measures that benefit jaebeol, it would be wise to reflect on what the Korean economy would look like today without the jaebeol system.

Could we have achieved such a dramatic leap from the utter poverty and backwardness of 1960?

*The writer is a research fellow in the Global Studies Department at Samsung Economic Research Institute. For more SERI reports, please visit www.seriworld.org.

By Jung Moo-Sup