The two South Koreas: an emerging love-hate relationship with direct foreign investment.

• Author: Graham, Edward M.

Everyone knows there are two Koreas--North and South. But when it comes to international business, there are also two Koreas within South Korea itself.

In one South Korea, it is literally a new day for foreign investors.

As the sunrise broke over the peak of Bongcheon Mountain on New Year's morning, an American corporate chief joined one hundred Korean employees to hike along a waterfall trail. Once they reached this peak, Nick Reilly, president and CEO of GM Daewoo, and Lee Seong-jae, chairman of the Daewoo Motor Labor Union, prayed for mutual success. "If the past was a time of struggling for survival, then the future will be a time of commitment towards growth and peaceful coexistence," Lee said.

In this South Korea, Deputy Prime Minister Han Duck-soo extols the virtues of direct foreign investment in South Korea. Such declarations have the ring of truth: South Korea is far more open to foreign investment than it was before the financial crisis of the late 1990s. As a consequence, both direct and portfolio foreign investment have grown enormously there since the crisis. Direct investment flows into South Korea averaged under $1.4 billion annually 1990-97, but jumped to an annual average of over $5.9 billion 1998-2004. Portfolio equity flows into South Korea were negligible before 1993, averaged about $4.2 billion 1993-97, and then jumped to an annual average of almost $9.1 billion 1998-2004.

Unfortunately, foreign investors can stumble into another South Korea. In this "second" country, Financial Supervisory Commission Chairman Yoon Jeung-hyun floated proposals for new rules that would impose Draconian penalties on foreign investors who attempt to exercise their shareholder rights. In this South Korea, foreign shareholders who become too vocal can be portrayed as "hostile" and "grasping." Somehow, the larger lesson has been lost--that South Korea has benefited enormously from foreign investment, and that experience strongly indicates that more foreign investment would mean an even more prosperous country.

Why do the benefits of foreign participation remain such a tough sell? In part, it is because many Koreans are still mired in the culture of the old-line "chaebols." These are conglomerates of often radically dissimilar enterprises in which a single family can dominate the holding company, and secretly infuse cash from strong companies (often bolstered by foreign investors) to float weak ones (usually run by a hapless relative). "Minority" shareholders rights are trampled upon, even when in fact "minority" non-family shareholders collectively hold a majority of the equity in a firm. Compounding the difficulty, the Korean government has acted recently in ways reminiscent of the chaebol heyday of the military dictatorships of Park Chung-hee and his successor, Chun Doo-hwan.

For example, no business case can be made for continued government pressure on banks to prop up Hynix Semiconductor and LG Credit, two hopelessly bankrupt companies; but bailouts, in the form of bank loans to these firms orchestrated by the Korean government, have been extended. (In fact, the...