‘Guanxi’ and ‘parachutes’ differ little in the end

Hyuncheol Bryant Kim
The author is a professor of economy and public policy at Hong Kong University of Science and Technology.

The 2008 Sichuan earthquake was a massive disaster that left 87,0000 Chinese people dead and 17,000 missing. Most of the deaths came from building collapses. Delving into the photos of the devastation, Yiming Cao, a professor of economics at the University of Hong Kong, couldn’t hide his embarrassment, as some structures remained intact even when other buildings completely fell apart. For instance, a kindergarten and a hotel near a primary school were not affected by the magnitude 8 earthquake at all even when the school fell to ashes.

Despite the magnitude 8 Sichuan earthquake in 2008, a kindergarten, left, and a hotel near the devastated Xinjiang Elementary School, center, remained intact. [NEW YORK TIMES]

What made the difference? Curious, Professor Yiming started collecting data on 1,065 public buildings in the province, including schools, hospitals and government buildings built between 1978 and 2007. He compared their year of construction and seismic design to the degree of their damage from the quake. It turned out that most of the buildings that suffered great damage had bypassed earthquake-resistant designs in the process of construction. If they had followed the seismic design guideline, the damage would certainly have been less severe.

How could such structures brazenly violating seismic design rules be built? The professor pointed to the guanxi culture in China, particularly hometown-related connections between stakeholders. In general, guanxi refers to informal interpersonal relationships based on school, blood and regional ties to promote their common interest. For example, if seismic design codes should be ignored to benefit a certain constructor, it calls for a guanxi between the constructor and the mayor who holds the authority to approve a completion inspection. Given the need to protect the mayor just in case, it requires another guanxi with his superiors.

A superior can appoint a junior as a mayor if he or she is from the same hometown as the superior’s and shows more loyalty than others. As a result, individuals — less competent than their rivals and more prone to corruption — can land a mayoral post thanks to their regional connection. Upon being appointed mayors, they must share economic interests with their bosses. Such corrupt guanxi chains inevitably weaken law enforcement by local governments.

Was guanxi really a primary cause of the Sichuan disaster? Prof. Iming closely checked if mayors and their superiors — mostly heads of provincial governments — were from same hometown at the time of completion inspection. The results were shocking: Buildings constructed in cities whose mayors enjoyed such relations were 75 percent more likely to collapse than otherwise.

Such corruption can hardly surface during normal times. Some outstanding cases could have been detected in the inspection or auditing procedure, but the corrupt system dismissed them. However, when a real crisis erupted, the price society had to pay was humongous. Due to the purely negative effect of guanxi, 75 percent more structures collapsed and 40,000 more deaths took place. The Sichuan earthquake was certainly a natural disaster, but the colossal damage the province suffered shows it was an unprecedented human disaster.

If you just laugh at guanxi and say, “China is still an underdeveloped country,” that’s a mistake. Actually, Korea is no different.

As an exchange student from Germany at Seoul National University (SNU) in 2008, David Schoenherr was interested in the popular phrase of “the Ko-So-Yeong S Line” at the time. The phrase was a satire on President Lee Myung-bak’s habitual recruitment of people from Korea University, the Somahng Presbyterian Church, the Yeongnam region and the Seoul Metropolitan Government for major posts in his government. After his inauguration as president, 12 CEOs of 42 major public corporations came from Korea University, Lee’s alma mater, or Hyundai Engineering & Construction (Hyundai E&C), where Lee served as CEO. (Before his inauguration, only three CEOs had such backgrounds.)

Schoenherr obtained his Ph.D. in finance from London Business School in 2017 by methodically analyzing the effect of the parachute appointments during the conservative administration. Partly thanks to the doctoral thesis which drew keen attention from academia, the German scholar could become an assistant professor of economics at Princeton University. Parachute appointments, largely relying on the president’s personal backgrounds such as Korea University and Hyundai E&C, ended up reinforcing the connections between CEOs of state-run corporations and private companies.

Such close bonds were formed at 31, or 16 percent, of 195 private companies which had participated in large-scale government bids. They can be called “personal connection-based enterprises,” which performed even better in grabbing government programs than the 164 companies without such presidential connections. The total value of orders the first group won in public biddings surged by 3 percent of their total assets — or an average of 100 billion won ($72.5 million) per company — compared to that of the latter group.

Were the results of contracts made from connections with the president successful? Such connections can play some positive role of sorting out reliable firms and jointly solving problems that may appear later. But if special favors are blindly offered to a certain company thanks to its personal connection with the president, that’s not only unfair, but can cause adverse effects. Fortunately, a deep analysis of the results of all contracts the government struck with the winners of public bids was possible primarily thanks to the transparent exposure of all the relevant process on the Korea On-line E-Procurement System.

But the results of the analysis were bitter. It turned out that companies with connections with the president exposed more problems in carrying out their contracts than companies without. For instance, the possibility of reneging on their initial contracts was eight to 11 percentage points higher for companies with such connections than not. In the category of architecture and civil engineering, the gap widened to 16 to 21 percentage points. The losses from the deviation are estimated to reach a whopping 45 trillion won — or 0.41 percent of the GDP — between 2008 and 2011 during the Lee administration.

I don’t think the former president wanted to proactively offer personal favors to his friends or acquaintances. Instead, he probably knew many competent CEOs around him and believed they would run public companies better than those without such experience, given his past experience in the private sector.

Other countries, too, face similar problems. They adopted diverse systems to fix them. The Organization for Economic Cooperation and Development (OECD) cited the United Kingdom, France and New Zealand as successful cases of recruiting executives for public companies. In the UK, related government ministers appoint heads of public corporations, and the Cabinet Office oversees the process. In France, the president appoints CEOs of public companies, but in the lead-up to the presidential decision, candidates’ academic ability, career and achievements are closely reviewed. Their appointments also require a consultation with — and endorsement from — the legislature.

In Korea, raising the transparency of the appointment process can be a better option. CEOs of public companies do not have to be experts in certain fields. To shake up those companies, injecting new blood is necessary. If the detailed standards and results of selecting and appointing CEOs of state-run companies can be made public, people can judge if the president selected the right person for the job.

About 150 heads of public institutions in Korea will be replaced by new faces this year. President Yoon Suk Yeol defined his predecessor’s appointments of CEOs of state-owned companies as purely “parachuting appointments” and pledged to not follow in his footsteps. Many former presidents made such a promise, but didn’t keep it.

This time, however, I hope President Yoon appoints innovative figures even without personal connections with him as heads of public entities through fair and transparent procedures.

The time has come for the public to keep a close watch on the recruitment process. The guanxi-based recruitment of government officials in China led to more than 40,000 extra deaths from the earthquake in 2008. The parachute appointments starting 2008 in Korea incurred 45 trillion won in national losses for the next three years.

Translation by the Korea JoongAng Daily staff.