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A Nation's Moment of Truth

Asia: Despite all the talk of reform, South Korea still can't resist shoring up failing firms. Whether it can learn to let go is key to any meaningful recovery, critics say.


DANGJIN, South Korea — This country was the model student of the International Monetary Fund, praised around the world for bouncing back so quickly from the Asian economic crisis of 1997. Now it is in danger of flunking out of school.

The reason can be divined here at Hanbo Iron & Steel Co.'s sprawling Dangjin Works complex, where a steady stream of 16-wheel trucks loaded with steel bar and coil head for the highway and the South Korean economy. Behind the walls, the massive, fiery blast furnace is pumping out enough steel to exceed last year's 1-million-ton production.

Trouble is, the economy is slipping, steel prices are falling and the company has been bankrupt for years.

Hanbo is a massive vanity project that underscores a central South Korean problem: Despite all the pledges of reform, the nation still balks at closing assembly lines and shuttering factories in the face of rampant overcapacity, no matter how unprofitable or debt-laden they may be.

Such faux reforms have come into stark relief as the South Korean economy steadily weakens. In recent months, the local stock market has lost nearly half its value, inflation is on the rise and consumer confidence is down.

Furthermore, foreign investors are walking away, economic growth is declining, scandals have undercut economic leadership and currency markets are increasingly volatile. The price of semiconductors, which account for 14% of national exports by value, has fallen nearly by half since August.

Few believe South Korea is on the brink of another full-blown economic crisis. Growth for 2001 is still projected to be a robust 5%, but that is barely half earlier forecasts, and some expect more downgrades to come. The labor market is more flexible than it used to be, and several of the nation's big industrial conglomerates have been restructured.

What the country is squandering, however, critics say, is the opportunity to transform its quick turnaround into a convincing, sustainable recovery.

And there's more at stake than simple pocketbook issues. An economically vibrant South Korea is arguably far better positioned to negotiate with its erratic neighbor to the north, to extend foreign aid as needed and to finance projects that may have little or no payoff--an issue of grave concern for the security of northeast Asia.

That danger was underscored by the recent near-collapse of Hyundai Engineering & Construction Co., which has bankrolled most of the big industrial projects north of the Korean demilitarized zone and which now struggles with $7 billion in liabilities. It also calls into question the decision by President Kim Dae Jung to use a giant conglomerate as a tool of foreign policy.

Meanwhile, the deteriorating economy is weakening political support among voters for the Kim administration, whose initial reformist measures had become the basis for optimism among foreign governments and investors.

At a demonstration early this month in front of Seoul's City Hall, several dozen Koreans in their 50s and 60s sit cross-legged on plastic tarps in the autumn chill, their shoes placed neatly beside them.

Cued by amplified chants from a portable microphone, they knock together rock-filled plastic bottles, protesting government moves to raise their rent and end the enormous subsidies doled out during the dictatorship of President Park Chung Hee.

"We're really having trouble making ends meet," says Ahn Sun Jo, a 60-year-old housewife wearing a protest banner. "We hoped this government would help the people."

The public's waning appetite for reform has emboldened opponents closely aligned with the old-line conglomerates, or chaebol, whose restructuring is perhaps the nation's single most important reform.

In retrospect, it seems clear that South Korea bounced back too quickly from its 1997 brush with bankruptcy. This earned the nation praise from the international community for its flexibility, its ability to learn quickly and its readiness to implement reforms.

Unfortunately, the country started to believe the buzz and to act accordingly. Many tough prescriptions were watered down, wait-listed and then abandoned altogether. A sharp run-up in stock prices in 1999 and early 2000, which salvaged bank and corporate balance sheets, turned out to be fleeting.

Allegations of favoritism in government decisions returned as credit taps opened again for both the worthy and the unworthy, making a sham of economic rationalism. This month the IMF warned that "zombie" companies endanger a financial system already weighted down with $100 billion in nonperforming loans. Even as leaders continued to champion reform, relatively little was done.

"It's called NATO--No Action, Talk Only," says Kim Tae Dong, chairman of the presidential commission on policy planning. "We wasted two very valuable years during which the world economy was booming. And now we're in a bad position."

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