Thursday, July 17, 2008

Wisdom in Crowds in Korea?

Michael B. Han, CFA Portfolio Manager
Matthews International Capital Management, LLC

Last month, South Korea’s decision to resume U.S. beef imports triggered massive protests in Seoul. For more than 40 days the city was moved by rallies that escalated into an outpouring of tens of thousands who took to the streets to oppose a trade deal they feared could expose the public to mad cow disease. The issue has posed a political crisis for South Korean President Lee Myung Bak, who took office following a landslide victory just four months ago.

Until about five years ago when a case of mad cow disease was detected in the U.S., South Korea had been among the top importers of American beef. Though many U.S. officials maintained that there were no statistically significant safety risks to U.S. meat exports, Korea, along with Japan and the European Union, imposed a blanket ban, later resuming conditional imports. Then in April, public outcry ensued when President Lee, a former chairman of Hyundai with a reputation for action that has earned him the nickname "The Bulldozer" agreed to lift the U.S. beef ban. The move was seen as one expected to help clear the way for a broader U.S.–South Korea free trade agreement that has been stalled. But by June, growing public uproar over the issue led Lee’s presidential aides to resign over the flap.

In and of itself, the reopening of the domestic Korean market to U.S. beef may not seem to justify the widespread furor that it unleashed. But what the public backlash really represents is Korea’s fear that its government is not acting in its best interest. The mostly peaceful protests have not been demonstrations against the U.S., or against free trade. Rather, the frustrations have been directed at the leadership’s lack of sensitivity to concerns over health risks, and highlight fears that the government prioritizes business over public safety.

President Lee has since publicly apologized over the situation and modified his earlier trade deal to limit U.S. beef imports to younger cattle, believed to be at less risk of mad cow disease. Despite the moves, however, the beef protests have given rise to sharp criticisms of the administration’s other plans for economic reform, including possible plans to privatize the public health care system and plans to build a grand canal. There have also been criticisms over Lee’s cabinet member selections.

How does a president’s landslide election victory plummet to record low approval ratings just a few months later? To begin with, South Korean voter turnout has been quite low, and many voters in the last election generally felt they were choosing between the “lesser of two evils.” Many protesters also regard President Lee’s beef deal as a rash and reckless act that stood to realize merely $1 billion in beef imports.

It is still unclear what will become of any free trade agreements between the U.S. and South Korea but the wider issue is that of Korea’s distrust of government. That Koreans feel inclined to take to the streets en masse may also indicate the lack of effective legal and political systems for public disputes. Compared to the U.S., Korea’s legal system is less approachable for the average person and the society is generally less litigious. When class-action lawsuits are not an option for protection, it is easier to understand why many may be moved to protest publicly. The danger, however, is that the political distrust is breeding voter apathy and diminishing turnouts at election time.

What is remarkable to note, however, is the ability of protesters to affect public policy. Following public backlash to the beef issue, the U.S. has reportedly looked further into establishing a system to verify the age of its livestock. The U.S. media has also begun to urge tighter regulation on the food inspection system. It seems that the aggregate wisdom of crowds and their voices have carried across the Pacific.

Evolution of Democracy
There are significant differences between the culture of demonstration in Korea now, compared to that of 20 years ago. Pro-democracy movements in South Korea in the 1980s were largely driven by college student leaders and frequently turned violent. Though recently there have been increasingly violent clashes between protesters and police, demonstrations over the beef issue began calmly when the majority of ordinary citizens participated. They have included young parents with children, executives in suits, middle school students, Roman Catholic nuns and Buddhist monks. Another important difference is that unlike the pro-democracy movements of two decades ago, the recent beef protests have involved no single, specific ideology, political leaning or special interest group. The protests involved passionate debate among participants, who remained respectful to each other. Commentators have credited Koreans for protesting peacefully, noting the high level of public participation as evidence of a maturing democracy. South Korea’s high Internet penetration rate, and its use of the Internet to mobilize the public over social issues, are also seen as signs of a highly educated society.

Indeed, Korea places great emphasis on education. It ranks fifth out of 35 developed nations in terms of its percentage of graduates under age 35 with four-year college degrees or higher, according to the Organization for Economic Co-operation and Development. The country also ranks third behind only India and China in terms of the number of students it sends to the U.S. each year to pursue higher education degrees. (In 2007, more than 62,000 Korean students came to the U.S. for school.)

The evolution of democracy in Korea is also evident in the decreasing signs of corruption where business and politics overlap. In the 1980s, two former presidents, Chun Doo Whan and Roh Tae Woo, had received illegal contributions of $1 billion and $500 million, respectively, from businesses. Both former presidents were convicted, and subsequent leaders have been accused of taking far less in kickbacks from business. The most recent offense—involving $10 million in controversial campaign contributions—by former President Roh Moo Hyun indicated there is a large decline in the size of dubious financial contributions to politicians.

Economic Democracy, the Next Evolution
Just as political democracy benefits grassroots movements, economic democracy benefits minority shareholders. Following the 1997 Asian financial crisis, Korean officials improved government transparency by adopting accounting standards similar to those of the U.S. The next step is to improve corporate governance.

In Korea, public participation, not activist hedge funds, paved the way to economic democracy. Non-government organizations (NGOs), which comprise professors and lawyers, have been involved in shareholder activism over the past decade. NGOs such as the People’s Solidarity for Participatory Democracy and Solidarity for Economic Reform, backed by minority shareholders’ voting rights, initiated a proxy battle against majority shareholders of what is known as chaebol, or large family-controlled conglomerates. Chaebols have played a significant role in the exportoriented growth of Korea’s economy. Though many chaebol affiliates have grown to become top-tier players in their fields, many could still benefit from improvements to corporate governance.

Armed with professional volunteers, NGOs have uncovered tax evasion cases or revealed other questionable corporate transactions that have benefited chaebol families at the expense of minority shareholders. NGOs are developing the skill of using litigation and proxy battles to enhance public awareness over complicated corporate governance practices. The organizations have also rallied against bad policy proposals regarding the adoption of poison pills.

Shareholder activism initiated by NGOs has also begun to move institutional shareholders. The National Pension Service (NPS), the country's leading institutional investor and the only national pension fund, voted against two business tycoons (both formerly convicted of fraud) who were seeking re-election to the boards of their respective corporate subsidiaries. The NPS’ first attempt to remove the two board members failed because the two tycoons had large holdings.

The fund currently has $220 billion in assets under management, and its asset allocation in the domestic equity market has been growing rapidly, which indicates that NPS may play a significant role in the future. There also appears to be a stronger likelihood that, going forward, people will be more concerned with corporate governance, which is critical to the performance of their retirement savings. Corporate governance and political transparency deserve more public attention than they currently receive. Fortunately, we continue to see signs of positive change—even if it’s in the form of surprisingly massive beef rallies. We see an evolving sense of democracy among those who are mobilizing to shape public policy. As these trends continue we hope minority shareholder value will be enhanced and a more vibrant sense of entrepreneurship will evolve.


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