Policy Ideas and Interest Alignment in the Process of Institutional Change in Chaebol Reform

Abstract

Reform is multi-faceted. Looking back on the history of South Korea’s political economy, South Korean society has displayed diverse patterns of economic reform in terms of goals, contents, means, and processes. Winners and losers have different notions of reform based on what potential benefit they can get from institutional change. Different stakeholders and actors may assume and pursue different goals, interests, ideas, and patterns of reform throughout the whole process of institutional change. Only fact we can agree on is that all reforms, for better or worse, take the form of institutional change. How can we identify the mechanism or politics, which often remain vague and mysterious, of institutional change? To answer these puzzles, we need to elaborate on institutional analysis by tracing the detailed process and examining how related variables interact on a specific issue in a critical period. Decoding the mechanism of institutional change has been one of the main research tasks in neo-institutional political economy. Diverse paths of institutional change can reflects the nature of real politics that define the internal workings of state behavior.

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2.1 Why Has Chaebol Reform Undergone Diverse Paths?

Reform is multi-faceted. Looking back on the history of South Korea’s political economy, South Korean society has displayed diverse patterns of economic reform in terms of goals, contents, means, and processes. Winners and losers have different notions of reform based on what potential benefit they can get from institutional change. Different stakeholders and actors may assume and pursue different goals, interests, ideas, and patterns of reform throughout the whole process of institutional change. Only fact we can agree on is that all reforms, for better or worse, take the form of institutional change. How can we identify the mechanism or politics, which often remain vague and mysterious, of institutional change? To answer these puzzles, we need to elaborate on institutional analysis by tracing the detailed process and examining how related variables interact on a specific issue in a critical period. Decoding the mechanism of institutional change has been one of the main research tasks in neo-institutional political economy. Diverse paths of institutional change can reflects the nature of real politics that define the internal workings of state behavior.

After the 1997 Asian financial crisis, the reform of South Korea’s chaebol drew considerable attention from both academic and practical worlds. Questions such as the following have been raised: Have South Korea’s chaebol changed? If the chaebol have changed, what changed and who triggered and led the change? If there was no change, why have they not changed and what is impeding the change? What is the unique aspect of the process and characteristics in the institutional change shown in the reform process of South Korea’s chaebol? This chapter seeks to explore the paths and driving forces of change in three cases of economic institutions, which have been the major debates for chaebol reform in Korea since the Asian financial crisis in 1997. Three issues portray the divergent paths of institutional change and chaebol reform in Korea along with the political dynamics of institutional change: (1) how to lift the ban on holding companies, (2) how to redesign the regulation on the gross amount of investment allowed in major big business groups, and (3) how to deregulate the 4 percent rule to protect financial capital from being merged with industrial capital.

While the three issues form the core of the South Korean government’s competition policy, they have been contentious in discussing chaebol reform. There were conflicts between the pro and cons regarding all aspects of institutional change, including the speed, scope, method, principal agent, and direction. Institutional change always creates winners and losers. The entire process of institutional change explicitly reflected the complex politics that occur as players struggle to win and avoid becoming losers. However, it is not easy to accurately draw the complicated politics of institutional change into one analytical framework. Despite many existing institutional analyses, there remain numerous issues that is hardly explained by conventional wisdom.

We emphasize several factors frequently used in institutional analysis to disclose more clearly and closely the reasons of institutional change. First, this paper analyzes the process and mechanism of institutional change rather than institutional change itself. This research is premised on the idea that the process of institutional change determines the outcome. Second, the concepts of interest and policy idea, which are used as conflicting variables in rational choice institutionalism and organizational institutionalism respectively, are emphasized as the core independent variables of institutional change. It also highlights the idea that the pattern and route of institutional change may shift according to the interaction between interest and policy ideas. Third, regarding the influence external pressure has on domestic institutional change, this chapter focuses on interest alignment between domestic actors instead of discussing the degree of external pressure.

The chapter is organized in the following way. The second part critically reviews existing institutionalist theories to construct the conceptual framework. The three cases analyzed in this chapter are unique because they underwent changes and reversals in a short period of time. Part three emphasizes gaps in policy ideas between foreign investors and domestic policy decision makers concerning issues related to lifting the ban on holding companies. The historical memory regarding holding companies and the gap between policy ideas determined the pattern of institutional change that relaxed regulations toward holding companies. Part four analyzes the process of alleviating and strengthening the ceiling on the gross amount of investment allowed. This case is an example where the direction and pattern of institutional change were determined by the change of the interest structure and incentives between domestic coalitions to strengthen and relax regulations in a relatively short period of time, irrelevant to pressure from foreign capital or interests. Part five analyzes the Lee Myung-bak administration’s sudden attenuation process of regulation preventing the fusion of industrial capital and financial capital. In this case, each actor’s individual interests are important variables. In particular, it is revealed that sudden institutional change is possible when the interests and policy ideas of the president and chaebol align. Part six presents the theoretical implications found in the case analyses to conclude the paper.

2.2 The Politics of Institutional Change: Policy Ideas, Interest Alignments, and the Role of External Pressure

Institutionalism emphasizes institutions as the most essential independent variable in analyzing human behavior, economic growth, societal change, and sources of power. Types of institutionalism are categorized in line with how the concept and role of institutions are defined and how the process of the building and change of institutions is analyzed. Types of institutionalism include rational choice institutionalism, historical institutionalism, organizational institutionalism, sociological institutionalism, and discursive institutionalism (Schmidt 2008). These paradigms started in earnest as an attempt to overcome the methodological limitations of the traditional structural-functionalist approach that was popular in the 1960s and 1970s. The intellectual origin of institutionalism traces back to the nineteenth century, when scholars began to philosophically agonize over the root of human society along with development of capitalism. Many philosophers such as Max Weber and Karl Marx started to research politics, the nation, power, economy, the market, and society using an interdisciplinary method. Most core concepts and logic recently receiving attention in institutionalism are problems that have been deeply ruminated over by a few key scholars for a long period of time. Especially from the 1990s, new institutionalism has been more actively discussed and developed for the purpose of refuting and supplementing neo-classicalism, the developmental state, and cultural approaches.

Regardless of the types of other paradigms within institutionalism, some notions and arguments that most literature in new institutionalism commonly agree on are useful in explaining reform and the process of institutional change of South Korean chaebol. First of all, institutions both restrict human behavior and social phenomena, and also facilitate change. Institutions, on the one hand, tend to constrain and shape the range of options from which actors are likely to choose as they engage in the political process of institutional change. However, on the other hand, institutions also provide principles, practices, and opportunities that actors use assertively as they pursue their interests and goals (Campbell 2004, 8). While historical institutionalism and organizational institutionalism emphasize the constraints of institutions and recognize that institutional change is both incremental and path-dependent, rational choice institutionalism signifies rational choice based on economic interests pursued by individuals even within constraints.

South Korea’s chaebol had to participate in economic activities under institutional constraints created by the state, such as regulations and competition policy. However, chaebol repeatedly grew by continuously attempting to alleviate institutional constraints for the strategic interests of their companies, or by using the existing institutions as a justification to expand. Secondly, institutions are composed of formal and informal institutions. Formal institutions refer to laws, acts, agreements, and procedures, and informal institutions indicate norms, customs, beliefs, codes of behavior, rules, networks, and culture and traditions within a community (North 1990, 4). Institutionalism, including rational choice institutionalism and historical institutionalism, perceives human behavior to be structured by a combination of formal institutions and informal rules. In organizational institutionalism, discursive institutionalism, and sociological institutionalism, informal rules such as taken-for-granted cultural frameworks, scripts, cognitive schema, historical traditions, and cultural inertia are emphasized as dominant variables (Schmidt 2012). Policy ideas or self-interest, major variables in this chapter, may be the rationally chosen outcome of actors or agents from the perspective of rational choice institutionalism. But from the perspective of organizational and sociological institutionalism, they can be seen as products naturally created in compliance with informal institutions that have already been long embedded in a particular society.

In South Korea’s political economy, institutional change can be easy or interrupted, depending on how formal institutions and informal institutions are combined. In particular, the issue of mock-compliance, which is criticized in South Korea’s chaebol reforms, is a concept which shows that informal rules and networks can play a more important role (Guillen 2003; Leković 2011, 363–367). No matter how well formal institutions are designed to modernize corporate governance, if informal rules or culture, which are difficult for formal institutions to influence, are not reformed, then it is difficult for South Korean corporate governance to comply with global standards. The core challenge of South Korean economic reform is how to reduce the gap between formal institutions and informal rules.

Third, formal institutions can change easily, but informal institutions do not change overnight. For formal institutions, when a new law is enacted or revised, existing institutions disappear or new institutions are built. New institutions among countries are formed through international agreements such as FTAs. Complicated politics certainly apply in the change process of formal institutions, so diverse patterns of institutional change appear by country and by case. But the change is made in a relatively short period of time compared to changes in informal rules. Although the corporate governance structure of stock companies is the most classic target and result of international regulation, even in the case of Netherlands, the birthplace of the system, there remain unusual informal institutions. This is because informal institutions or cultural characteristics, which are embedded in political settings and social structures, still strongly define institutional change and corporate governance structures. In Japanese corporate governance structure reform, there is a stronger resistance against foreign investors in a sector with stronger embeddedness, so in such a case, compliance with global standards is the lowest (Ahmadjian and Robbins 2005). In South Korea’s chaebol reforms, it is not an exaggeration to say that the changes that occurred in informal rules determine the outcome of the whole institutional change.

Fourth, it cannot be denied that policy ideas emphasized in historical institutionalism, or the notion of interest emphasized in rational choice institutionalism, are important factors in explaining individual behavior or the operation principle of society. Yet, a more important question is whose ideas and whose interests they are. No matter how advanced a country’s democracy is, its political economic power and resources are unevenly distributed. Universal suffrage or expanded enfranchisement cannot represent the power relations in the actual market and politics. So, it is important to see what ideas and what interests a person or a group in an important position in a power structure has. Institutional arrangements reflect power relations. It is difficult to find a case that equally fulfills everyone’s ideas and interests in the process of institutional change. The same political change can be positive reform for some people, and change for the worse for others. In reality, it is difficult for the general purpose and outcome of reform to be universally accepted by all groups. In the discussion of East Asian regionalism, the same understanding can be applied to the analysis that the idea that each major East Asian leader has regarding regionalism and globalization determines the outcome towards regionalism (Acharya 2009). At least in South Korea, the ideas and interests of laborers or farmers are not that meaningfully reflected in the formation of various regional institutions such as FTAs.

Fifth, when investigating the questions of who builds institutions and when, it is generally agreed that normally institutions shape politics, and in a crisis politics shape institutions. In Douglas North’s book, he raises the question of “Are we free because we have a constitution, or do we have constitution because we are free?” (North 1990). He argues that during a time of peace, humans can be free because of laws and institutions, and during a crisis humans can create new laws and institutions due to political choice. In other words, “institutions explain everything until they explain nothing” (North 1990). In a society like South Korea, where many political economic incidents and institutional changes were compressed into a short period of time, the politics of actors who build and change new institutions explain more than the constraints provided by institutions. In particular, to analyze the drastic changes and reforms at major critical junctures such as the Korean War in 1950, the 1961 military coup, the 1987 democratic consolidation, the 1997 Asian Financial Crisis, and the 2008 Global Financial Crisis, we should look at the role of politics in punctuated equilibrium or institutional discontinuity rather than institutional continuity (Moon and Rhyu 2010).

Even if we accept the usefulness of institutionalism, methodological challenges to explain the various patterns of institutional change and political dynamics still remain. First of all, there are many discussions regarding institutional change, but most analyses concentrate on the causes, agents, and triggers of institutional change. The major factors of these analyses are the intensity, strategic interest relations of domestic interest groups, and the ideas and leadership style of the chief policy decision makers, and the majority of the key issues are contracted as competition and the interaction of globalization versus the nation-state (Cortell and Peterson 2002; Lee 2005, 2008; Gourevitch and Shinn 2005; Lim 2010). However, there is a frustration in empirically describing the specific mechanism of the process of institutional change. In actuality, there are innumerable factors that trigger institutional change. It is difficult to concretely specify, detect, locate, and trace what interests and purpose each actor has towards institutional change, and explain how they drive institutional change. Moreover, it is difficult to fully reveal the interactions or correlation of all actors.

Second, much research on institutionalism focuses on comparing or categorizing the pattern of institutional change by analyzing the degree and scope of institutional change. In other words, the research categorizes whether institutional change is incremental, or evolutionary, or whether it is episodic, or revolutionary. Even in the same case of institutional change, depending on the time frame, it can be analyzed as being incremental or revolutionary. An incremental change can be seen as a revolutionary one if one analyzes a brief period. On the contrary, a revolutionary change can be categorized as an incremental one when a long period is analyzed. According to the time frame, a microscopic change can create a great discontinuity, and a large macroscopic change can merely be an incremental continuity. Cases of institutional change, including the enactment of the 1890 Sherman Act and the 1914 Clayton Act, changes in economic philosophy after the Great Depression, changes in world order after the end of the Cold War in 1991, and the adoption of the 2014 PPACA: Patient Protection and Affordable Care Act also known as Obamacare, can all be identified differently depending on the time frame used in analysis.

Third, there are many core concepts that are used in institutional analysis that are not yet clearly defined, or which remain controversial according to contending paradigms. The notion of policy idea, which appears as an important independent variable in the process of institutional change, is also largely vague and controversial (Campbell 2004, 91–92). Ideas may include policy, norms, beliefs, programs, and philosophy, and appear in different forms, such as narratives, frames, frames of reference, discursive fields of ideas, argumentative practices, storytelling, and collective memories. The policy ideas provide guidelines for political action and serve to justify programs through arguments focused on their interest-based logic and necessity (Hall 1989; Schmidt 2010, 2). The policy ideas may also change when windows of opportunity open in the face of events, and as old policies no longer solve the problems or fit the politics for which they were designed (Kingdon 1984; Seabrooke 2006). These changes may be fast or slow, and they may be incremental or abrupt. But what remains unclear is whether events drive change in policy ideas or whether ideas open windows, creating new opportunities for policy change, and what makes actors believe that windows of opportunity are open (Campbell 2004; Schmidt 2010).

How and on what level, and under what sequence, do policy ideas and interests influence each other? In rational choice institutionalism, interest is the most important factor of institutional change (North 1990). When an existing institution does not benefit the actor, and becomes less efficient, political action towards institutional change begins. On the other hand, in historical institutionalism or organizational institutionalism, political ideas and interests are already reflected in the institution and organization, so interests do not trigger institutional change, and action and interests are constrained by rules, procedures, norms, and cultural frames (Steinmo et al. 1992). However, confusion regarding the conceptual category of ideas and interests still remains. Currently, there is no agreed upon point of view stating whether policy ideas cover interests or whether interests incorporate policy ideas, or if it is meaningless to differentiate between interests and policy ideas in the actual stage of change of an institution. Furthermore, there is no consensus regarding whether it is ideas or interests that are first defined. On the one hand, policy ideas may come before interests, acting as ‘road maps’ for individual actors to clarify their goals or limit the range of strategies to be taken – in which case ideas seem to determine interests. However, if this is the case, then we still have no explanation of the selection mechanism by which certain ideas get chosen over others. On the other hand, ideas may come after interests, acting as ‘focal points’ for actors to choose among equally acceptable alternatives – in which case ideas serve at best to ‘mop up’ residual variance, and we still can’t explain the mechanism by which the now exogenously interest-determined ideas are picked. In addition, interests and ideas are not fixed, and can shift according to various elements in each phase. So the relation and interaction between interests and ideology becomes more complicated.

Then, how can we identify the unique pattern of institutional change in South Korea’s chaebol reform? South Korean institutional change, particularly the series of chaebol reforms that progressed after the 1997 Asian Crisis, was fast in speed and broad in scope, the pattern was very abrupt and drastic, and external pressure and the state are seen to have played the biggest role. This sort of change can be compared to Japan’s slow and incremental change and the development of China’s private sector (ten Brink 2011; Nee and Opper 2012), and also to the market or society-led pattern of reform in the US or Europe’s. However, looking at specific cases, it is difficult to identify institutional change in a single pattern, and there are various elements that trigger institutional change. In addition, according to the time period, there are plenty of phenomena that make it difficult to see that South Korea’s institutional reform was fast and abrupt. In reality, after almost 20 years of a series of economic reforms that were instituted following the 1997 Asian Crisis, there is wide acceptance of the criticism that South Korea’s chaebol did not in fact change. Recently, there is a phenomenon that the developmental state, which was a target of reform, is not dissolving, but is rather reviving and reorganizing. Within the argument that regardless of numerous changes in formal institutions, many informal networks and culture deeply embedded in South Korean society and politics have not changed (Lee and Rhyu 2008), there are also arguments suggesting that as a source of external pressure, foreign investors do not always pursue transparency and accountability, but sometimes hinder and delay reform for their own interests.

Meanwhile, in many cases of institutional change, there has been a frequent reshuffling of structure and power relations of pro-reform and anti-reform coalitions concerning chaebol reform. Then, efforts to identify South Korea’s institutional change pattern into a single model and to compare it with the patterns of other countries may no longer be valid. A more academically meaningful research task may be undertaking a detailed case analysis to reveal that there are diverse patterns and paths of institutional change.

This chapter attempts to answer the questions of why and how does South Korea’s institutional change shows a variety of patterns and routes. First of all, it focuses on the process and mechanism of institutional change. Institutionalists claim that institutions enable, empower, facilitate, constitute, and constrain actors, by which institutions help to guide or shape action. However, institutions do not work in vacuum. Institutions and actors constantly interact with and influence each other. Then, what make institutions work? How do institutions work better or worse? How do institutions and actors interact? How can we describe and identify the detailed inner mechanisms and process of institutional change?

This chapter conducts case studies to suggest a more detailed answer to these questions. It analyzes the cases of the relaxation of regulations regarding the establishment of or transfer into holding companies, the change of restraints on the gross amount of investment within chaebol groups, and the change in 4 percent regulation to prevent the fusion of financial and industrial capital. The scope, purpose, and issues of institutional change are clear in each case, and they took place within a relatively short period of time. However, the interests and ideas of many actors were bound up intensely with one another. How such ideas and interests have changed, along with how they are tied to action, will be traced using the concept of “process tracing” (Campbell 2004, 121). On a micro-level, this chapter analyzes how policy coalitions are reshuffled around the objective, scope, and path of institutional change.

Second, this chapter emphasizes the combination form of policy ideas and interests as the independent variable that determines the unique pattern and route of institutional change. How policy ideas and the interests of major actors combine, and how the combined form reshuffles during the process of institutional change, determines the pattern and path of institutional change. The nature of the process or mechanism of institutional change, which this paper aims to emphasize, can become more precise by analyzing how policy ideas and interests interact. These ideas serve as guides and principles to actors on what to do, as well as the source of justification and legitimation.

Actors pursue their interests by identifying and promoting their personal interests as the substance of ruling ideas and discourse (Campbell 2004, 28). However, interests are subjective ideas, which, though real, are neither objective nor material. On top of that, ideas and interests are dynamic, intersubjective constructs rather than static structures. They evolve over time and change their real face along with controversial policy issues. Moreover, the ideas and interests of actors sometimes diverge rather than converge over specific timing or issues. This paper carefully specifies detailed behavior, remarks, and stories on how the major actors in each case reflect their ideas and interests. It also specifically reconstructs the dynamic politics within an appropriate time frame over how interest-based policy coalitions disaggregate or reorganize.

Lastly, this chapter analyzes whether the interests of foreign actors, which are the source and substance of external pressure, are aligned with the interests of domestic actors as an independent variable rather than analyzing the existence or degree of external pressure. If their interests are aligned, the width of institutional change broadens, its pace quickens, and the direction tends to become irreversible. However, when their interests collide and the direction of reform diverges, institutional change is restricted and delayed, and according to the change in political economic conditions, the path of institutional change becomes a zigzag form.

While it is true that the pressure of globalization is pushing for domestic institutional reform, the interest of foreign investors is to make money, not to positively reform the institutions of host countries. Transparency and accountability do not necessarily guarantee the interests of foreign investors. Furthermore, the composition and interests of foreign investors are not monolithic. They vary according to industry, country of origin, and by reform issue. We cannot simply assume that the interests of foreign investors will always be coherent and unified on specific issues. Although the strong pressure of globalization cannot be ignored, no matter how weak the host country is, the domestic politics of a nation-state still remain an important factor that determines the path of institutional change. No matter how strong external pressure is, there is no case that does not pass through the state mediation of the host country and that reforms or changes institutions exactly according to the demands of external pressure. Consequently, to realize their interests, foreign investors search for a policy coalition partner within the host country who shares their ideas and interests. The existing institutionalism perspective which provides an opposing analysis that dichotomizes globalization and the nation-state cannot capture this interest alignment mechanism. These three cases concretely portray the various politics of interest alignment between foreign investors and domestic actors.

2.3 Lifting the Ban on Holding Companies: The Conflict of Ideas Between the Government and Foreign Investors

2.3.1 Divergent Ideas Between the State and Foreign Investors

A holding company is a parent corporation that owns outstanding voting stock in another company. It does not produce goods and services itself and exists only to hold shares of and to control affiliated companies. It generally controls the board of directors of son or grandson corporations using the power of ownership or invested capital, thereby deciding and monitoring their key policies and management. The benefits of using a holding company can be numerous and span everything from stronger creditor protection and tax savings to making a business more saleable through easier acquisition and divestiture planning. On the flip side, the disadvantages of having a holding company are for the most part limited to the added legal and accounting costs and complexity associated with incorporating and maintaining one. These key benefits, for investors, which are not typically available through regular corporate structure, outweigh the cost of changing an existing regular company to a holding company or of founding a new holding company. Many large corporations in modern capitalist markets, such as General Electric or Bank of America, take the form of a holding company.

Even though the forms of holding companies may be identical, the policy ideas surrounding them can be extremely different. The social norms, historical traditions and memories, and policy frames surrounding a holding company can be formed not just around the management and organizational advantages and convenience, but also from the unique political economic characteristics shown in a particular society’s history of capitalism and growth process of the company. In the history of Anglo-Saxon capitalism, holding companies are one of the most modernized forms of corporations to develop in capitalism by protecting the investors and expanding investment. As Anglo-Saxon countries experienced the damage of the monopoly of large conglomerates as early as the nineteenth century, and created strong anti-trust laws and monitoring systems to regulate this monopoly power, there was the simultaneous creation of a social norm to monitor and minimize the harmful effects of holding companies. There was a strong positive policy idea towards holding companies. For foreign investors, holding companies were the strongest institutions that embody the keywords of globalization, transparency, and accountability. After the 1997 Asian financial crisis, foreign investors and international financial organizations such as the IMF and the World Bank strongly pushed the South Korean government to allow holding companies in order to achieve South Korean chaebol reform.

In South Korea’s history of capitalism, holding companies were a type of corporation that held extremely negative images and memories. First of all, in South Korean society, holding companies immediately brings up the image of the old Japanese large conglomerates before the Second World War. The South Korean government fostered chaebol, which copied the form of the Japanese zaibatsu, as the champions of economic growth. Japanese zaibatsu, combined with Japanese militarism, were perceived as having colonized South Korea, supporting imperialism during the World War II and committing numerous war crimes. They were symbols of opacity, collusion, recession cartels, market monopoly, the forced drafting and exploitation of South Koreans, and the destruction of democracy.

This impression and historical memory of old Japanese zaibatsu were not limited to South Korea. The first measure taken as part of ‘post-war democratic reform’, which the MacArthur general headquarters (GHQ) implemented in 1946 after their occupation of Japan, dismantled six holding companies of large conglomerates in the finance and industry sectors, and introduced a system prohibiting the establishment of pure holding companies. The GHQ perceived holding companies of large conglomerates as the economic foundation that started the war, monopolized the market, and destroyed democracy. With the start of the Cold War in 1947, MacArthur allowed for the establishment of operating holding companies in Japan in alignment with the changing strategic interests of the US. However, the international society continues to hold a negative policy idea towards Japanese zaibatsu. Until 1997, pure holding companies were not allowed in Japan.

In addition, the 1997 economic crisis was sufficient to maximize South Korean society’s negative perception of holding companies. At the time, there was a strong belief among South Koreans that the cause of the economic crisis lay in the typical management failure of chaebol, such as reckless diversification strategies, sloppy management, family-controlled management, corrupt links between business and politics, and excessive loan management. The dominant perception was that chaebol who had received active support from the Park Chung-hee administration rather indulged themselves in opaque management practices and corruption, and their absorption of the too-big-to-fail practice brought on the economic crisis and pain to the people. As the old zaibatsu holding companies of Japan had left behind the pains of war, South Korea’s chaebol now brought the ‘sovereign default’ crisis to South Korea.

It strengthened the negative image of and critical policy ideas toward holding companies. In this situation, it was unimaginable to allow South Korea’s chaebol to establish holding companies. Furthermore, after 1986 in South Korea, various chaebol regulation policies were strengthened through the Monopoly Regulation and Fair Trade Act with the objective of constraining the economic concentration of the top 30 corporate groups. These restrictions included ceilings on the gross amount of investment, prohibition of the establishment of or transfer to holding companies, prohibition of mutual investment, restrictions on debt guarantees, and prohibition of the fusion of financial capital with industrial capital.

It became clear that there was a large gap between foreign investors and major players in Korea in terms of policy ideas towards holding companies. The legalization of holding companies was a good direction of reform for foreign investors but it was a change for the worse for the general public in Korea. Such a gap in policy ideas was a factor that made the institutional change legalizing holding companies, which was proposed as the core tool of chaebol reform by foreign investors and international financial institutions right after the 1997 economic crisis, difficult. From the perspective of foreign investors at the time, it was a rational method to improve the transparency and accountability of the chaebol. Although they strongly pressured the South Korean government, the Kim Dae-jung administration resisted the demand to allow the establishment of holding companies even as he actively accepted all other demands.

2.3.2 Converging Interests Among Stakeholders

Regardless of this undeniable existence of gap in policy ideas, what was the main factor that made the South Korean government change its initial opinion opposing the legalization of holding companies and suddenly agree to do so? The background behind South Korea’s initial opposition and subsequent turnaround 15 months later seems to lie in the convergence of interests between the related domestic economic stakeholders and those applying external pressure. Following the demand by the Federation of Korean Industries (FKI) to permit the transformation of holding companies on February 4th, 1998 the Fair Trade Commission (FTC) restrictively allowed for chaebol to transform into holding companies in May of 1999 only after going through a complicated review process. The FTC announced a legislative bill allowing only corporations that had completely settled their mutual debt guarantees between chaebol corporations to transform into holding companies.

The Asian financial crisis facilitated rapid changes in corporate governance structure. An economic environment with a completely open capital market and legalized hostile takeovers has made increasing competitiveness and protecting management rights an urgent challenge for South Korea’s chaebol. Even before the economic crisis, chaebol demanded that holding companies be legalized. As a countermeasure to this market pressure, on February 4th, 1998, the FKI formally suggested that the government permit the establishment of holding companies for the first time (Chosun Ilbo, February 5, 1998a).¹ It was the business world’s response to the measure passed by then president-elect Kim Dae-jung’s emergency planning committee, which allowed hostile takeovers. The FKI argued that “efficiency in corporate governance structure should be sought by permitting the establishment of holding companies, and the capability of management rights to engage in defense should be ensured through the creation of holding companies.” Following this request, the FKI made several more proposals to permit the early establishment of pure holding companies in its meetings with related departments, (The Korea Economic Daily, April 9, 1998a). The FKI’s demand was affected by the demands of foreign capital that hoped to invest in South Korea. The UK semiconductor communications company GEC group and the engineering company TI group conveyed to the South Korean government through various channels the point that even with investment, without the ability to establish holding companies, there would be difficulty in financial management (Dong-A Ilbo, December 16, 1998). Similar to Japan’s lift of its ban on holding companies, the demands of foreign corporations to invest directly influenced the decision to lift the ban on holding companies.

There was strong external pressure demanding South Korea to lift its ban on holding companies. Along with realistic demands that lifting the ban on holding companies was needed, there was also a strong perception that transparent business management and chaebol reform were required. When the IMF approved the fund withdrawal of the scheduled two billion dollars on February 17th 1998, it proposed conditions to improve the transparency of corporate governance structure in South Korea, including the obligation to combine financial statements and improve accountability to stockholders. Through the abolishment of mandatory bids, domestic hostile takeovers were agreed to (Ministry of Finance and Economy, IMF Measures Task Force, February 1998). At the second meeting for the introduction of structural adjustment loans on September 25, 1998, the World Bank applied direct and active pressure, declaring that it would not provide the two billion dollars if South Korea did not “revise the Monopoly Regulation and Fair Trade Act permitting holding companies and preventing economic concentration” (Ministry of Finance and Economy, Public Loans Task Force, September 1998; Joongang Ilbo, September 25, 1998a).²

Domestic politics in the US and the lobby of related industries also acted as external pressure on South Korea for chaebol reforms, including pressure to lift the ban on holding companies. At the federation budget review that included the additional supply of 18 billion dollars to the IMF, US Congress specified a special regulation measure so that IMF funds would not support certain parts of businesses in South Korea (The United States Senate, October 2, 1998, Title 6 Sec. 602). In other words, it prohibited government subsidies, tax privileges, and relief loans towards corporations and industries related to semiconductors, steel, automobile, shipbuilding, textiles, and clothing. There was also an obligation for the US Minister of Finance to regularly report to the Congress to check compliance (Dong-A Ilbo, December 16, 1998).³

Compared to the US side, South Korean business’ demand for the lifting of the ban was relatively modest. The FKI emphasized abolishment of regulations that could introduce corporate governance such as the prohibition of the establishment of holding companies, suggested by the OECD’s recommendation of corporate governance structure reform guidelines (The Federation of Korean Industries, November 1998, 2). Although the FKI demanded that the government lift the ban on holding companies as a precondition to chaebol reform, it did not make specific suggestions. While holding companies were a possible alternative for the business circle, a sudden change to a holding company system was impossible in reality. Samsung group’s 1998 management renovation plan was the first formalized reference to holding companies at the individual corporate group level (Samsung Office of the Secretary, January 1998, 10).⁴

After a short period of time, the Kim Dae-jung administration was in a situation where the legalization of holding companies would earn political gains due to the strong external pressure and changes in domestic political economy. The government was aware that the holding companies system should be introduced to strengthen competitiveness and promote corporate restructuring. The economic reform proposal⁵ reported by the then president-elect Kim Dae-jung’s economic policy task force, or the emergency economic measures committee, included lifting the ban on holding companies.

However, the Kim Dae-jung government faced opposition even from government agencies. On November 18, 1997, the FTC opposed the business circle’s demands to lift the ban on holding companies, stating that it was premature to establish holding companies (Joongang Ilbo, November 18, 1997b). Chun Yoon-chul, the chairman of the FTC, affirmed that “at the moment, our conditions do not yet allow for the autonomous correction of the harmful effects of economic concentration” and implied that it would maintain its regulations that permit economic concentration (Chun 1997, 2). Caught between external pressure from international financial institutions and domestic opposition, the Kim Dae-jung administration decided on a position that would restrictively lift the ban on holding companies with the presumption that it would minimize the harmful effects of economic concentration. On January 19th 1998, Chun Yoon-chul determined that “with introduction of consolidated financial statements, the establishment of holding companies will be permitted,” showing a leap of change in policy (Maeil Business News, January 20, 1998a).

A complicated political process was developed centering around the interest relations regarding the conditions of lifting the ban on holding companies. Influenced by Japan having lifted its ban on holding companies, the Fair Trade Commission engaged independent scholars and launched a project to evaluate the holding company system. This report proposed that when transparency in operation management is secured, there will be a need to lift the ban on holding companies, and also suggested a few conditions for lifting the ban that could eliminate the harmful effects of holding companies.⁶ Soon after, in April of 1998, the FTC organized a public-private committee to revise the Monopoly Regulation and Fair Trade Act. This committee was established following the “recommendation from the World Bank stating that an economic policy should be implemented more effectively and there is a need to improve the weaknesses that were revealed in the process of implementing the Fair Trade Law.”⁷ The contents in the above independent report and the recommendation from the public-private committee were used as a reference when the FTC drew up the revised Fair Trade Law. The M&A Division of the FTC drew up a restricted permission plan for holding companies in April of 1998 (Fair Trade Commission 1998a). The aim of the restricted ban lift was to “utilize the proper function of holding companies in supporting the smooth promotion of restructuring for concentrating the core competencies of companies.” The proposal restrictively lifted the ban on holding companies: (1) it limited the debt ratio of holding companies to 100%, prohibiting direct cross investment between holding companies and subsidiary companies; (2) it mandated a share ratio of holding companies to subsidiary companies of over 50%; (3) it prohibited simultaneous ownership of financial subsidiary companies and non-financial subsidiary companies; and (4) it completely resolved the debt guarantees of the top 30 conglomerates (Fair Trade Commission, April 28, 1998b).

In the process of preparing the revised Fair Trade Law, bureaucratic politics within government departments were not absent. The Ministry of Finance and Economy abolished the regulation requiring holding companies to maintain a debt ratio of no greater than 100%, allowing for the free borrowing of foundation funds, and proposed to set the lower limit of the shareholding rate of holding companies to higher than 50%. This is known to have reflected the demands raised in the meeting held between the CEOs of the top 5 conglomerates and economic bureaucrats on July 26, 1998 (The Korea Economic Daily, July 29, 1998b).⁸

In April of 1998, the Ministry of Commerce, Industry and Energy requested the FTC to permit holding companies without restrictions in the case of restructuring firms and to promote restructuring and tax incentives and President Kim Dae-jung agreed to this. The FTC’s decision to hastily prepare a revised proposal to allow a restricted lift of the ban on holding companies, which was a turnaround from their previous opposing stance, can be interpreted as a response to internal concerns that if the FTC continued to stick to its opposition, the leadership over the issue of holding companies may go to the MOCIE (Maeil Business News, April 20, 1998b). Moreover, the MOCIE had recently advocated industry’s position, emphasizing a paradigm shift of government policy from a supervisory function to an adjudicatory function, and determined that the conditions for the establishment of holding companies needed to be relaxed in order to build an efficient industrial structure (The Korea Economic Daily, December 18, 1998e). For the MOCIE, it was a strategy to reappear as an economic policy planning department rather than simply a regulatory organization.

MOCIE’s strategy was a movement that could threaten the FTC. A competition structure among departments was formed. So, even just to cancel this out, the FTC had no choice but to take an aggressive pro-legalization stance, although the position it took maintained restrictions on holding companies. In addition to this, there were other sporadic occurrences of bureaucratic politics between bureaucrat departments surrounding economic policy. In the summer of 1997, in the midst of the dispute over lifting the ban on financial holding companies, although the MOFE did not oppose permitting financial holding companies to exist, it was, at the same time, concerned about the reduction in tax revenues that would occur in the process of introducing financial holding companies. Thus, it took a passive position towards institutional change (Joongang Ilbo, July 3, 1997a).

Meanwhile, there were conflicts of attribution between the FTC and the Ministry of Justice surrounding the introduction of a dual system modeled after the US, where the prosecution holds the rights to suits in civil and criminal cases, and the contesting authorities also hold the rights to suits to strengthen sanctions towards violating competition law. There was also a jurisdictional dispute between the FTC and the MOCIE surrounding the dispute over whether introducing competition- restrictive industrial policy without prior consultation with the Fair Trade Commission was in violation of the Monopoly Regulation and Fair Trade Act.

Although there were demands from academia, civil groups, and business circles at public hearings (The Korea Economic Daily, September 17, 1998c),⁹ the first revised bill by the FTC was accepted without changes. The president carefully watched the progress of chaebol reform to schedule the holding company system. At the National Congress for New Politics (NCNP) officiated party briefing in September 23rd 1998, president Kim Dae-jung instructed to “review chaebol restructuring” (The Korea Economic Daily, September 21, 1998d). As the direction of top 5 conglomerates’ restructuring was determined at the meeting between political and business worlds on December 7, 1998, Kim Won-gil, the chairman of the NCNP policy committee, declared that there was no reason to delay lifting the ban on holding companies, and announced that implementation would start in 1999 (Joongang Ilbo, December 8, 1998b). This debate between the president and the political world was greatly influenced by the advice of the World Bank. An NCNP policy committee member confirmed that “considering resistance from civil groups, the establishment of holding companies should have been deferred. However, the Kim Dae-jung government permitted the holding companies system to reflect advice by the World Bank (The Korea Economic Daily, September 17, 1998c).

Labor organizations such as the Federation of Korean Trade Unions (FKTU) and the Korean Confederation of Trade Unions (KFTU) argued for chaebol reform but they did not express an official view on lifting the ban on holding companies. Also, because their opposing views were not elaborated, the Kim Dae-jung government did not reflect the views of the People’s Solidarity for Participatory Democracy (PSPD) in the policymaking process. On the contrary, the FTC faithfully followed the president’s instructions to push for a restricted lifting of the ban and strengthen its organization. The World Bank argued that instead of legalizing holding companies, the FTC’s investigation right should be strengthened. The World Bank advocated that in order to strongly restrict the anti-competitive behavior of chaebol, the power to search and confiscate should be given to the FTC (Chosun Ilbo, October 4, 1998b). Despite opposition from the business world, the FTC, supported by such external pressure, secured the right to chase the financial accounts of businesses suspected of engaging in anti-competitive behavior.

The desire to stimulate the economy and strengthen political power also worked as an impetus behind the Kim Dae-jung government’s decision. The Kim Dae-jung administration remained caught in the dilemma. One the one hand it demanded chaebol reform. On the other hand, it had to stimulate the economy by encouraging chaebol investment. A rapid economic revitalization was desperately needed to overcome the serious recession that followed the economic crisis and to recover social stability. The Kim Dae-jung administration had to find a middle ground in the collision between policy ideas and interests. Furthermore, the legalization of holding companies was aligned with the interests of foreign investors and international financial institutions. For foreign investors, the policy idea and interests regarding the legalization of holding companies matched exactly.

Eventually, despite the large gap between the government and foreign investors in terms of the policy ideas on holding companies, the holding companies system was legalized as the interests of the Kim Dae-jung government, foreign investors and international financial institutions, and chaebol converged. Under the situation where South Korean society and the Kim Dae-jung government continued to hold a negative policy idea towards holding companies, implementing a restrictive lift of the ban on holding companies proved an optimal middle ground for all relevant interest groups.

2.4 Regulatory Politics on the Gross Amount of Investment: Various Matches of Policy Ideas and Interests

2.4.1 Divergent Policy Ideas Among Domestic Actors

According to Article 9 of the Fair Trade Act, any company belonging to an enterprise group shall not acquire or own stocks of an affiliated company exceeding a certain ratio of its net assets. This provision shall not apply to state-owned companies, holding companies, or foreign companies. It was one of the key regulations of Monopoly Regulation and Fair Trade Act that the South Korean government introduced in 1987 to prevent economic concentration among the top 30 large conglomerates. The investment limit within the same group was relaxed from 40% to 25% of a parent company’s net assets in 1994. However, in February of 1998, right after the economic crisis, the South Korean government abolished the limit to protect the management rights of South Korean companies and to induce restructuring as a countermeasure to the M&A of foreign companies. In April of 2001, the Kim Dae-jung administration revived the investment limit following a resurgence of the harmful effects of the diversified management of chaebol and a deepening of economic concentration. However, in March of 2009, the limit was again discontinued due to the continued opposition of chaebol as they argued it was anachronistic in the age of deregulation and globalization. Until now, the limit is a distinctive regulation that uniquely exists in South Korea. With the deepening economic concentration of chaebol and consequently strengthened anti-chaebol sentiment from the people, there are voices demanding the reintroduction of the limit.

The South Korean government’s policy idea regarding this regulation was in total opposition to the policy idea held by the chaebol. The government considered the regulation on the gross amount of investment to be essential in preventing unrelated diversification strategies and to lower economic concentration. The government and civil society shared the idea that market competition was impeded by chaebol monopolies. It was also thought that the increased debt of the chaebol may endanger the national economy. It is true that the heavy chemical industrialization strategy which started in 1972 brought about compressed growth. However, the people and the government had historical memories regarding chaebol of monopoly, duplicated investment, and the liquidation of repeatedly insolvent enterprises through injections of tax payer money, which were the background behind these strengthened restraints on the gross amount of investment.

On the contrary, large conglomerates had the policy idea that the investment of a company should be determined by the company, and the government should not control it. They also believed that deregulation helps strengthen the competitiveness of companies and the overall development of the national economy. In chaebol’s view, the regulation not only hinders efficient allocation of resources, but also causes government failure and inefficiency. Chaebol argued that restraints on the gross amount of investment hinders the ability of existing companies to expand investment through takeovers. The regulation also makes it difficult to enter a new market such as the high-tech industry that is relatively high risk because entry into such industries requires a large initial capital investment. They also claimed that if a foreign company that is free to invest in domestic companies attempts a hostile M&A, it is difficult to defend management rights. The government’s policy idea towards this system is natural considering South Korea’s experience of adhering to a state-interventionist industrialization strategy, and its institutional and cultural inertia. It was difficult to close the gap between the policy ideas of the two groups. This gap has persisted since the early 1960s, when South Korea embarked on its developmental state modeled economic growth.

Foreign investors and international financial institutions did not have a particular policy idea or interest in South Korea’s peculiar restrictions on the gross amount of investment. First of all, the regulation did not apply to foreign investors operating in the South Korean market and was only enforced for domestic large conglomerates. The regulation would not influence the activities of foreign investors in the South Korean market. Foreign investors shared similar policy ideas with chaebol groups in that they should respect international rules on deregulation. However, foreign investors and international financial institutions thought that most harmful effects such as the opaqueness and monopoly of chaebol would be resolved if the corporate governance structure improved through the introduction of a consolidated accounting system and strengthened competition policy. Because the interests of foreign investors in this regulation were neither clear nor certain, they did not apply external pressure towards institutional change.

However, policy ideas do not operate in the political vacuum and are not realized into specific polices without modifications. Depending on the timing, stage of policy, and certain other issues, policy ideas can sometimes coincide or discord with the interests of actors. Policy ideas are expressed in specific policies or institutions after interacting with the various interests of actors. Foreign investors did not have any interests that would have led them to pressure the South Korean government to relax regulations regarding the changing direction and content of restrictions on the gross amount of investment. The regulation neither matched the policy ideas of foreign investors, nor disturbed their specific interests. Foreign investors did not make concrete actions the South Korean government to relax regulations, the regulation did not generate direct influence on foreign investors.

2.4.2 Changing Interest Alignments Among Domestic Actors Over Time

Before the crisis, there was a widely held presumption that the government implicitly guaranteed to eliminate risks for chaebol investments. In one sense, this policy had the right intention of trying to limit chaebol from over indulging in moral hazard, which foreign investors would certainly see as desirable. In another sense, such a discretionary restriction on investment can only be interpreted as just another heavy-handed intervention by the government to arbitrarily alter market outcomes. As the theory of policy reform tells us, policy reform measures should always try to get at the source of the problem, not just mask its symptoms. In this sense, it is not analytically apparent as to whether restrictions on the gross amount of investment actually would help contain the chaebol problem, or make the problem even worse. At very least, such a measure can be seen as an outright intervention that adds a regulatory burden to the economy, contradicting the principle of free and open competition. In sum, the interest and ideas of foreign investors cannot be identified with clarity regarding this institutional reform agenda.

In a structure where external pressure does not act in the specific process of institutional change, convergence or divergence of the interests between the domestic actors shapes the direction of change and width of the shift in the ceiling on the gross amount of investment. The incentive structure and interests of a particular period and the policy ideas of conflicting actors determined the method of how policy ideas are reflected in institutional change. The interests of domestic actors have been reflected more strongly than the voice and interests of foreign investors. Since the interests and voices of foreign stakeholders rarely came into view, no interest alignment and policy coalition directed by foreign investors and international financial institutions could be formed in the process of institutional change regarding this specific agenda.

After the financial crisis, the Korean government had initially eliminated the previous restrictions on gross investment. While this action could be interpreted as pro-globalization measure, a deeper reason behind it was the government’s desire to provide the chaebol with a level playing field by giving them a way to protect themselves against hostile takeovers by international investors. In the process of the 1997 economic reform, the Kim Dae-jung administration promoted a reform strategy based on neo-liberalism. The Kim Dae-jung administration used to prefer a development strategy led by the middle class and small and medium-sized enterprises, while restraining the chaebol market monopoly. However, in the middle of a sovereign default, it could only accept the neo-liberal policy ideas demanded by the IMF and international capital. President Kim also abolished the restrictions on the gross amount of investment from a realistic need to stimulate the economy, and could not remain a spectator in the midst of the domino of chaebol bankruptcies. At the time, even the civic groups that held anti-chaebol sentiment did not oppose the abolishment of the regulation on the gross amount of investment under the economic nationalist policy idea of not allowing South Korean companies to be sold to foreign corporations at dirt cheap prices, and opposing the drain of national wealth.

However, after the restriction was repealed, the gross investment of chaebol subsidiaries continued to increase and a growing criticism emerged saying that chaebol reform had retreated. The ratio of investment rates in the 30 largest conglomerates increased from 29.8% in 1998 to 35.65% in 2001. Moreover, liquidity problems faced by Daewoo and Hyundai Electronics at that time placed a lot of political pressure on the Kim Dae-jung administration. At the same time, the Kim Dae-jung administration faced limited options because it would not be possible to recover from the recession and complete corporate restructuring efforts without help from the chaebol. The government simply could not tie the hands of the chaebol again. Hence, the government underwent its most drastic program of deregulation ever while at same time trying to maintain the principles of chaebol reform. The compromise reached then in the Fair Trade Act was to allow many exclusionary clauses in the Regulation on the Gross Amount of Investment and allow deferment for 3 years. The eventual outcome was that, although restrictions were resurrected in April 2001, they did not have a real impact on regulating chaebol activities (Table 2.1).

Table 2.1 The political process of institutional change concerning the restriction on the gross amount of investment (1997–2003)

During this process, chaebol/the opposition party and the government/the ruling party held opposing interest alignments. Chaebol and opposition party in favor of deregulation aligned to repeal or incapacitate the restrictions on the gross amount of investment. The Grand National Party (GNP), the opposition party at the time, was a party that represented the interests of the chaebol. By contrast, the government and the ruling party, an anti-deregulation policy coalition, came together to limit the chaebol to break the myth of “too big to fail” by tightening the restrictions on chaebol investment. The ruling Millennium Democratic Party (MDP) originally had the policy idea of opposing chaebol monopolies. Civil society, which held strongly anti-chaebol sentiments, also put strong pressures on the Kim Dae-jung administration to promote chaebol reforms.

Why did the Kim Dae-jung administration reintroduce a regulation that contradicted chaebol reform in April 2001? First of all, after the economic crisis, the Kim administration was at a critical juncture where they could only accept the neo-liberal measures to relax regulations. But Kim Dae-jung’s policy idea, as summarized in the so-called mass economy theory, emphasized democratic control of the economy (Rhyu 2013). As South Korea repaid all of its debt to the IMF in one and a half years, Kim Dae-jung’s longstanding policy idea of regulating chaebol began to influence government policies. Furthermore, immediately after the financial crisis, when the IMF, which formed an axis of Kim Dae-jung’s policy coalition, exited, Kim Dae-jung’s political interests in reshuffling and strengthening regulations formed a policy coalition with the anti-chaebol South Korean civil society.

The Kim Dae-jung administration desperately needed a strategy to strengthen his political foundation, facing a reality where the fruits of economic reform did not directly benefit the middle class or the people despite the smooth progress of the economic reform. In his Independence Day speech in 1999, Kim Dae-jung emphasized the necessity of chaebol reform by saying the following: “The five principles promoted for chaebol reform – improvement of transparency, settlement of cross payment guarantees, specialization of industry, and strengthening of management accountability – should be completed without a failure. Moreover, the financial domination of chaebol through subsidiary financial companies will be prevented. Chaebol reform can only succeed with the prevention of the financial domination of industrial capital. Cross-share holding and unfair inside transactions will be deterred, and irregular successions will be stopped thoroughly. I will become the first president in Korean history to reform the chaebol, and restore the economy to center on the middle class” (Kim Dae-jung Presidential Library and Museum 2015).

The ruling MDP’s defeat in the 16th general elections in April 2000 was a trigger for Kim Dae-jung to further emphasize chaebol reform. This election served as an interim evaluation of the economic reform and economic stimulation policies of the Kim Dae-jung administration. The Kim Dae-jung administration underwent some self-reflection and concluded that the people were not actually feeling the benefits of the Kim government’s economic reforms. The administration also perceived that the electors withdrew their support because they were disappointed that the spirit and principle of chaebol reform was destroyed. The election results were a big loss for the Kim Dae-jung government, and it went against their crucial interests. In order to avoid a situation where their interests were threatened again, the Kim Dae-Jung government reintroduced its restrictions on the gross amount of investment in April 2001. However, the degree to which the newly introduced ceiling on the gross amount of investment was determined according to the political economic interests that the Kim Dae-jung government pursued.

The political imperative to revitalize the domestic economy was also an important factor in facilitating institutional changes toward extensive deregulation. In October of 2001, Lee Nam-gi, the Minister of the FTC, stated that the relaxation of chaebol reform was unavoidable due to the serious economic depression. This indicates that domestic political logic and interests strongly influenced the institutional change mechanism. Under the circumstance, chaebol continued to demand relief from regulations and pressured the government to make the regulations ineffective. Bureaucratic politics took place within the government. The MOFE and the Ministry of Industry and Energy (MIC) preferred that these regulations be flexibly applied, due to their concerns over the need to revitalize the economy and placate the interests of the chaebol. The FTC held strongly to its position due to its organizational interest as a major agency responsible for monitoring the chaebol. In this process, the voice of civil society was nearly absent.

The ceiling on the gross amount of investments was finally officially abolished again in March 2009 under the Lee Myung-bak administration that hailed globalization and deregulation as a new political agenda. As the political grip on chaebol weakened, the power of chaebol within the domestic political economy strengthened, consequently leading to the eventual repeal of the regulation restricting the gross amount of investment. Ultimately, regulatory changes in the gross amount of investment is another example where the pattern and direction changed according to how ideas and interests combined in concrete political processes. An examination of this case confirms that while conflicts between the two policy coalitions existed, the shifting interests over time resulted in repeated institutional change. The Kim Dae-jung administration’s dilemma between siding with the people’s propensity towards strong anti-chaebol sentiment and the need to strengthen its weakened policy coalition with civil society, and siding with the economic interests that can only borrow the power of chaebol to revitalize the economy created ongoing tension, and the interactions between these two sides resulted in shifts between regulation and deregulation.

2.5 Deregulation of the 4 Percent Rule: Interest Alignments Between the President and Chaebol

2.5.1 Traditional Policy Ideas on Competition Policy in the Financial Market

The question of whether separation of industrial capital and financial capital should be repealed has been an issue for a long time. The current regulation that separates industrial and financial capital originated in Venice banks in Medieval Europe, where regulations prohibited them directly trading in copper, tin, and iron. At the time, there were also concerns that banks would monopolize trade. The regulations on fusing financial with industrial capital vary in each country according to its perspective on the role of the finance industry and banks, power relations, and historical experiences. Germany completely permits this fusion, as it perceives the role of banks to be that of a long term investor helping to stabilize industrial capital rather than that of an institution pursuing private gains.

On the contrary, in the US, with the introduction of the 1993 Glass-Steagall Act, and the 1956 Bank Holding Company Act, strong regulations were maintained to reduce the damage from the fusion of industrial capital with financial capital. However, regulations go through cycles of tightening or relaxation depending on changes in government policy ideas or the outbreak of an economic crisis. Currently, industrial capital is limited to owning 25% of financial capital. However, in the US, it is still prohibited for banks to own non-financial industries.

In the UK, there is no direct limit of ownership regarding shares in banks, but when a non-financial company becomes a controller holding more than 10% of bank stocks, according to the Financial Services and Markets Act, it must go through an eligibility screening by the FSA. Japan also permits direct cross-shareholding between the manufacturing industry and financial industry, but the limit of ownership is regulated to not exceed 5%. In contrast to South Korea, the purpose of this policy in Japan is to prevent the traditionally larger and stronger financial conglomerates from owning industrial conglomerates. All countries in the world are commonly aware of the possible harmful effects that the monopolization of industrial capital and financial capital can bring about.

South Korea is one of the countries that is most proactive in its regulation of the fusion of financial and industrial capital. In 1995, South Korea introduced a system that strongly regulates this fusion by preventing it from occurring in advance. According to the Banking Act, “No non-financial business operator may hold more than 4/100 of the total number of outstanding voting stocks of a bank (15/100 in cases of a local bank), if a non-financial business operator obtains approval from the Financial Services Commission for stocks of a bank he/she intends to hold beyond the limit set out on the condition that he/she will not exercise his/her voting rights in the stocks… he/she may hold such stocks up to [10/100], [those of the financial or insurance company shall not exceed 15/100 of the gross number of stocks issued by the said affiliated company].” Despite many debates in the meantime, the separation rule, which was maintained under the policy idea of preventing the financial domination of chaebol, was changed during the Lee Myung-bak administration to raise the limit of ownership from 4% to 9%. What made such a sudden institutional change possible? In particular, why was such institutional change possible, even in a situation which, unlike the 1997 financial crisis, lacked strong external pressure to deregulate?

The core of South Korea’s traditional economic model lies in government-led economic development strategies and resource allocation through government-controlled credit allocation. The South Korean developmental state can be summarized as the allocation of policy finance through banks that are controlled by the government and discretionary monetary policy by bureaucrats. For a long time before actual industrialization began, South Korea did not have a well-developed private financial ecosystem. Most financial institutions started out as public enterprises, and even after privatization, at least until the 1997 economic crisis, were continually managed by the direct intervention of the government. Traditionally, there were insufficient financial resources, so there was a clear limitation on the role of private companies supplying capital to the market. The government always had to directly provide important funding. In this way, there was strong perception of the financial industry and banks as a public good. The financial industry was perceived not as a subject of investment to make a profit, but as a public policy tool to support the national economy and economic growth.

The South Korean government nurtured the chaebol as an engine of economic growth. But it was intolerable for chaebol to dominate banks. Ownership of banks by chaebol would damage the public nature of the banks, and it could only be perceived as a private company interfering in the government arena. South Korea’s economic growth model, and the unique relationship of government-chaebol-bank implied in this model, became the background of the policy idea that strictly controlled the fusion of industrial and financial capital. Major civil activist groups with strong anti-chaebol sentiments shared a similar policy idea with the government. The core policy idea to strengthen the separation of financial and industrial capital is that if the separation of industrial and financial capital is relaxed, chaebol can turn banks into their private vaults. And because chaebol could concentrate loans towards their loan subsidiary companies, it would lead to heightened economic concentration and hindering competition in the financial market. This would likely eventually damage the rights and interests of the national economy, financial consumers, and the people.

Foreign investors do not have a consistent policy idea regarding separation of financial capital and industrial capital. Some countries allow for the fusion of financial and industrial capital, and even if a country regulates it, there is a wide variation on the limits of ownership. There is not a particular policy idea towards South Korea’s regulation policy apart from the general rule from the perspective of the rule of market economy and neo-classicalism that competition in the financial market should not be hindered, and that government-led credit allocation should not continue.

When chaebol power in the South Korean market strengthened from the early 1980s, chaebol began to have the policy idea of opposing direct intervention of the government and emphasizing market autonomy. They began to promote this specific ideology to make it the dominate policy idea in South Korean society. It is an undeniable fact that chaebol engaged in various political activities such as lobbying and applying political pressure in order to push for cooperation between the National Assembly and bureaucrats to make institutional changes to their advantage. There was no special reason for international capitalists to oppose chaebol policy ideas supporting market autonomy and the reduction of government intervention. The chaebol policy idea of abolishing regulations regarding the separation of financial and industrial capital is rooted in the logic that if the state does not follow global standards and step away from the market, and regulation of separation of financial and industrial capital is not repealed, South Korea’s finance industry will be unable to improve its competitiveness, and eventually it will not help the national economy or the interests of the consumer. Chaebol and the policy coalition that supports their policy ideas argued that the matters that the government is concerned about are already monitored through other regulations, so the regulation of the separation of financial and industrial capital is redundant. They also argued that it is reverse discrimination to allow 10% for foreign capital while limiting South Korean industrial capital only to 4%. Furthermore, the deregulation policy coalition argued that the genuine intentions of the government are to maintain ongoing control over the banks and sustain the regulatory power of bureaucrats.

2.5.2 Interest Alignments Between the President and Capitalists

Why was there sudden change in deregulation under the Lee Myung-bak administration despite the government’s possession of a strong policy idea regarding the separation of financial and industrial capital? The international comparison does not suggest that deregulation under the Lee Myung-bak government completely changed the traditional policy idea regarding the separation of financial and industrial capital. There was a relaxation on the ownership limit, but the rule of separation of financial and industrial capital did not fundamentally change, and the government’s direct control over banks was maintained using a variety of channels. Under the Park Geun-hye administration, every time a major financial incident or chaebol insolvency became a social problem, strong voices were raised arguing for a retightening of the separation of financial and industrial capital in both the opposition and the ruling parties.

In addition, after the 2008 global financial crisis, 2009 was a period when almost all countries in the world, including the US, tightened financial regulations. However, South Korea underwent a sudden institutional change in the opposite direction, which is quite interesting. What made such deregulation possible? In short, this sudden institutional change was brought about by the interest alignment of President Lee Myung-bak with the chaebol at a particular time. The traditional policy idea of the South Korean government did not completely change, but President Lee Myung-bak’s personal policy ideas and interests neutralized traditional policy ideas, resulting in institutional change along a particular pattern and path.

Disputes regarding the separation of financial and industrial capital were first formed in October of 2003 after Lone Star took over Korea Exchange Bank. The Roh Moo-hyun administration tried to adhere to the principle of separation of industrial and financial capital which seeks to prevent the ownership of banks by domestic chaebol. Interestingly, in November of 2005, Yoon Jeung-hyun, the Chairman of the Financial Service Commission, made an official remark that the principle of separation of industrial and financial capital should be relaxed.

On the background of these remarks, different views against the official view of the Roh Moo-hyun administration were suggested. The Chairman of the FSC criticized the separation of financial capital and industrial capital after Samsung group drafted the so-called ‘The Roadmap for Samsung Bank’ in May 2005 (Kim 2007). With the purpose of creating a Samsung financial holding company, Samsung attempted to change public opinion to favor deregulating the separation of industrial and financial capital, and a lobbying strategy. When the complete text was made public by the opposition party member Congresswoman Shim Sang-jung during the National Assembly’s Strategy and Finance Committee, the political strategy of Samsung to deregulate the separation of industrial and financial capital became revealed (Suh 2011).

The remarks of the assistant Minister of MOFE, Kim Suk-dong, demonstrate that there were conflicting views among bureaucrats over the issue of separating financial capital and industrial capital. In 2005, there was a heated controversy over the issue due to the Samsung Card’s violation of the law and the revision of the law to insert a penalty clause. The Chairman of the FSC made comments, supporting stakeholders with similar views including the director of the Bank of Korea and the presidents of domestic major banks and financial institutions, and representatives of opposition parties (e.g. the Grand National Party).

As can be seen in this case, despite having the policy idea of the separation of industrial and financial capital, the Roh Moo-hyun administration failed to control bureaucrats in the actual process of policy implementation and was not free from Samsung’s lobby and political influence. Lawmaker Hong Jong-hak pointed out that because the ruling Uri Party and the Democratic Party had problems as there were few legislators interested in chaebol issues, president alone could not take the lead in chaebol policy (Table 2.2).

Table 2.2 The political process of easing regulations on the separation of industrial capital and financial capital in Korea (2005–2009)

The Roh Moo-hyun administration’s failure acted as a favorable factor in the Lee Myung-bak government’s relaxation policy of the separation of industrial and financial capital. In his public speech at the National Assembly, president Lee, with his presidential election pledge to ease the separation of financial capital and industrial capital contrary to President Roh, requested cooperation in passing the bills for the revision of the 4 percent rules. It was quite an exceptional case that the president gave pressure to pass specific bills in the National Assembly (Suh 2011, 51). President Lee Myung-bak mentioned during his presidential campaign that it was necessary to ease principle of separation of financial capital and industrial capital as foreign investors have primary control over domestic banks and the policy acted as counter-discrimination against domestic capital, as observed in Lone Star’s sell off of its controlling stake in Korea Exchange Bank (KEB), which it bought from majority shareholders at a fire-sale price in 2003. So relaxing the separation of financial capital and industrial capital was his major presidential election pledge. President Lee’s policy idea was based on the idea of enhancing the global competitiveness of the domestic financial industry through business-friendly policies and increasing the rate of economic growth.

The Northeast Asian financial hub strategy begun with the Roh Moo-hyun government provided a positive justification for Lee Myung-bak’s administration to promote deregulation in the financial industry. It worked as a justification and discourse strengthening the logic behind the Lee Myung-bak government’s pledge to increase the international competitiveness of the banking industry. Although on April 22, 2008, Lee Kun-hee, the chairman of Samsung, officially announced that Samsung group would not enter into the financial industry due to growing criticism over the Samsung group’s lobbying, it can only be seen as a temporary deferral strategy employed due to concerns about the large amount of capital necessary to transform into a financial holding company, and the shock of reshuffling the ownership structure. Working in close cooperation with the Samsung group since the presidential elections, president Lee Myung-bak was active in chaebol reform to help Samsung’s entrance into the financial industry. Regardless of Samsung’s declaration of renunciation, president Lee strongly pushed to ease regulations on the separation of industrial capital and financial capital based on his business friendly strategy. President Lee Myung-bak understood that the participation of chaebol was essential to develop South Korea’s commercial banks into international investment banks and to privatize the Korea Development Bank. This, in combination with the reality that South Korea’s major banks were already owned and dominated by foreign capital and after the 1997 economic crisis, resulted in the nationalistic sentiment that South Korea could not give the Korea Development Bank, which is the symbol of South Korea’s financial industry, to foreign capital, also playing a role.

Policy debates surrounding the policy of separation of industrial and financial capital took the form of an interest confrontation between the regulation coalition and the deregulation coalition. The regulation policy coalition consisted of the opposition party, NGOs including PSPD and Citizens’ Coalition for Economic Justice (CCEJ), labor unions, and trade unions such as KCTU and FKTU. They claimed that easing the 4 percent rules would give more economic power to chaebol and that banks under chaebol subsidiaries were likely to become private coffers, which would be contrary to the interests of the shareholders. The regulation policy coalition pursued the political interests of reclaiming political power through reducing consumer damage resulting from chaebol market monopolies and building up anti-chaebol sentiment by maintaining regulations.

The deregulation policy coalition was made up of bureaucrats (including MOFE, Financial Supervisory Authorities and the FTC), the ruling party, and domestic interest groups (including FKI, bank associations, etc.). They argued that easing the 4 percent rules would not lead to domestic banks becoming the private coffers of chaebol through the strict application and reviews from the institutional setting, such as reviews of the eligibility of majority shareholders (Suh 2011, 56–64). In addition, to enhance the global competitiveness of domestic banks, size matters, and combining financial and industrial capital could bring a greater synergy effect to the domestic economy. The Lee Myung-bak government had a specific interest in restructuring the government by strengthening financial competitiveness and stimulate the economy.

Given the Lee Myung-bak government’s interest alignment with chaebol and the support from bureaucrats, the deregulation coalition had a greater number of supporting stakeholders. Bureaucratic support was largely the result of the appointment of senior economic bureaucrats who shared the same policy ideas or market views with the president himself. While the regulation coalition was scattered, the promoters and supporters of easing the separation of financial and industrial capital built a more intense interest coalition, which created a good environment for President Lee to drive his policy interests. Institutional change to ease the separation of banking and commerce was driven by this mechanism, in an abrupt and drastic pattern and path, by President Lee Myung-bak, empowered by his interest alignment with the chaebol.

Foreign investors did not apply any specific external pressure regarding institutional change of South Korea’s separation of financial and industrial capital. After the 1997 economic crisis, the Kim Dae-jung administration strictly maintained the 4 percent ceiling, but permitted the ownership of foreign capital in South Korea’s financial industry to reach 10%. However, in reality, this rule was not applied, so foreign capital in Standard Chartered Korea Limited, Citigroup Korea, KB Financial Group, Shinhan Financial Group, Hana Financial Group exceeded 50%, and in three of these banks, a non-Korean is still the majority shareholder. For the South Korean government, which was desperate for an inflow of foreign direct investment after the economic crisis, it indefinitely permitted foreign financial capital to own domestic banks because it could not apply strong regulations to foreign capital entering South Korea’s financial industry.

At the time, the urgent need for inflows of foreign capital itself worked as the origin of external pressure. Because financial capital from major countries sufficiently entered South Korea’s financial industry immediately following the economic crisis, there was no need to pressure for deregulation for additional entry in the process of institutional change after 2005. Furthermore, because in the US, according to their own Banking Act, banks could not possess industrial capital, US capital did not have much interest in applying additional pressure for institutional change to own South Korea’s banks. Foreign capital had no interest in pressuring the South Korean government to permit the fusion of financial and industrial capital, but it had an ongoing interest in maintaining pressure on the South Korean government regarding government privileges granted to chaebol as an extension of government-controlled credit allocation in order to prevent chaebol from having an unfair competitive advantage.

In addition, traditionally, South Korea’s financial industry was underdeveloped, and could not compete with international financial capital. So, even if the Lee Myung-bak administration eased the separation of financial and industrial capital and created conditions advantageous to South Korean chaebol, international investors were not that interested in the issue. In the same vein, President Lee Myung-bak formalized a strategy to permit chaebol participation in the privatization of major banks, and contain the participation of foreign capital, but it seems as though international investors did not think that the South Korean government’s easing of regulations on the separation of financial and industrial capital greatly harmed their interests. In addition, in contrast to the policy ideas of Kim Dae-jung or Roh Moo-hyun, the policy idea pursued by Lee Myung-bak’s administration were of creating a business friendly environment and deregulation, which was in line with the policy ideas of international capitalists emphasizing globalization and the principle of the market. Thus, international capitalists did not oppose the Lee Myung-bak government’s easing of the separation of financial and industrial capital, and remained a passive actor in the policy coalition for easing regulations on the separation of financial and industrial capital.

Although South Korea’s policy ideas regarding chaebol reform and regulations did not completely change at least under the Lee Myung-bak administration, the policy ideas regarding the separation of financial and industrial capital underwent considerable changes. Under the structure where the Lee Myung-bak government’s strategy of institutional change did not seriously hinder the interests of international capital, the Lee government could achieve rapid institutional change by exploiting his interest coalition with the domestic chaebol. Under the situation where the interests of the president and chaebol coincide and foreign investors do not voice opposition, the political balance of power between the regulation policy coalition and the deregulation policy coalition collapsed, showing a drastic and abrupt pattern of institutional change.

2.6 Conclusion

This chapter shows the political process of the way in which institutional change occurred in chaebol reform. The legalization of holding companies was achieved through strong pressure from foreign investors and international financial institutions on the Kim Dae-jung government. Under strong external pressure, the Kim Dae-jung government could only postpone its policy ideas and follow realistic interests. This shows that the nation-state and international capital can have completely different policy ideas regarding the same institutional change issue. Policy ideas and interest relations vary within the political process of institutional change. Since foreign investors did not have a particular policy idea or interests regarding restrictions on the gross amount of investment, the policy process went through abolishment, reintroduction, neutralization, and re-abolishment.

South Korean chaebol reform showed a great deal of adaptive capacity in the process of institutional change. Factors such as interest alignment and convergence of policy ideas determined these various paths. When policy ideas and interests collide, it is interests rather than policy ideas that can more strongly influence institutional change. Major actors, both domestic and international, shared the same interests even if they had different policy ideas regarding a particular institutional change.