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[Kim Jin-guk] New subcontracting law will damage the economy

It has been more than a year since the government introduced the “fair society” concept as its governing philosophy. One major aspect of it has been encouraging “joint growth” between small and medium-sized enterprises and big business groups ahead of major elections next year.

The revised bill on fair subcontracting transactions allows SME industry associations the right of collective negotiation over prices with their major buyers. It also requires primary suppliers to prove why they should pay less for any contracts and introduces strict penalties and terms of indemnification for damages. The law will take effect by the end of June. An interesting question is whether the tightening rules will really help mutual growth by both large and small companies.

Subcontracting transactions are essentially a consignment contract. What is a contract? It’s a legal means for the contracting parties to bind themselves with pre-agreed rights and obligations in case there are possible changes in a business deal. Signing a contract in the market economy is a type of legal expression and subject to civil law.

But our current legal system assumes that companies do not run their business in line with contracts. Fearing large companies abusing their dominant market power, authorities have tried to protect weaker suppliers with the fair trade law and then beefed up the firewall with the subcontractor law.

The problem is that if the law bans large producers from cutting contract prices from their suppliers, even marginal subcontractors will survive, leading to higher prices for consumers. What’s more worrisome is that the primary and secondary suppliers, not big businesses, will be hit the hardest. Large companies are relatively prepared to cope with changing rules but most of the primary and secondary contractors are hardly ready and may have trouble absorbing the blows.

A bigger problem is that the government has always ignored consumers’ interests for the sake of protecting SMEs. The state-imposed guarantee on small suppliers’ earnings will benefit sub-contractors but lead to higher production costs that would then be passed onto consumers.

Another issue is that the heavily-subsidized local companies has to compete with global rivals. If they do business only in the local market, sharing the costs and profits can be feasible. But as an economy relying on exports, Korea may head into a collapse as the protection will erode the price competitiveness of both large and small producers.

Big business groups will likely switch to cheaper overseas suppliers if domestic subcontractors raise their contract prices due to the new regulations. In this case, the primary, secondary and tertiary contractors will be hit first, and badly. I wonder whether policy makers and lawmakers are aware of the risks.

Many Korean companies won’t be able to survive in the intensifying global competition unless they work together to reduce production costs and develop technology. Sustainable growth is possible only when they improve quality on the basis of price competitiveness.

The economy cannot move to the next level if the government continues to protect SMEs and ignores consumers, the final judges of an economic policy and the main agents of economic activity. The new subcontracting law as written is flawed, will do more harm than good and should be revised even though major elections are looming.

By Kim Jin-guk

The author is dean of Appenzeller School of Global Business at Pai-Chai University and  an adjunct scholar with the Center for Free Enterprise in Seoul. ― Ed.