South Korean economy: What exactly is a chaebol?

For investors considering investing in South Korea (EWY, quote), it is imperative to understand the role that chaebol plays in this economy. So, what exactly is a chaebol?

Image courtesy Ben Franske: http://commons.wikimedia.org/wiki/File:Samsung_CES_2009.jpg

Samsung is probably the world's best-known chaebol

Concisely, chaebol is the Korean word for family-owned conglomerates. These firms dominate the South Korean economic landscape. Because of a government that has fostered the growth of chaebol, many have grown to become some of the largest corporations and most recognizable brands in emerging markets, including Samsung (SSNLF, quote), Hyundai (HYMLF, quote), LG Display (LPL, quote), and SK Telecom (SKM, quote).

Many chaebol were formed in the late 1940s when the Korean government began to work closely with the private sector to meet the challenges of post-war development. The relationship intensified in the 1960s, when the government allowed chaebol to develop monopolies and secure easy financing as a key growth strategy. Through the leadership of the first-generation owners, the conglomerates grew rapidly and helped modernize the stagnant and war-torn economy.

However, the chaebol ran into considerable difficulties during the Asian financial crisis of 1997. Nepotism among second- and third-generation owners and decades of state protection led some firms towards crony capitalism. This saw some chaebol deviate from the dynamism that allowed them to prosper in the first place. Instead, certain firms veered towards more inefficient operations, namely an overgrowth of unprofitable subsidiaries led by family members who were often weak managers. Parent companies were able to use cheap credit and accounting loopholes to hide losses until the crisis hit.

In the wake of the Asian financial crisis, the Daewoo group, one of the largest chaebol, had to be dismantled. Smaller conglomerates like Halla and Ssangyong Motor also disappeared. Others, like Hyundai, successfully reformed and led South Korea’s post-crisis rebound. Since the Asian financial crisis, the remaining chaebol have led South Korea’s transition from an emerging to developed economy, with some economists predicting the South Korean economy will overtake Japan by 2017 in terms of per capita GDP.

However, the relationship between the government andchaebol remains a controversial issue in South Korea. As is the case with monopolies everywhere, concerns abound that these behemoths stifle smaller, potentially more innovative competition. While this iteration of chaebol leadership, namely Samsung, has embraced dynamism, fears persist that a future generation of leaders might not be so prescient.

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