No Quick Fixes for South Korea’s Economic Woes

The country’s export-driven economy is straining to adapt.


Summary

South Korea’s economy, which relies on exporting high-value-added manufactured goods, has experienced slowed growth as a result of the ongoing global exporters’ crisis. This report examines the current status of the South Korean economy. It identifies both external threats and internal challenges, and it also discusses the government’s attempts to address them.

  • Slowing economic growth and consistently declining exports have put strain on South Korea’s economy, and this strain has manifested as political pressure to act. The South Korean government has attempted to make long-term changes to reorient the country’s economy, and it has also introduced short-term efforts to prevent industry collapse.
 
  • The largest external threats to the South Korean economy are twofold: over-reliance on exports (particularly to China) and decreased global demand for some of its largest export industries, including refined petroleum and shipbuilding.
 
  • Internal threats include strict labor laws, economic dependence on massive conglomerations like Samsung and Hyundai, rising household and national debt and increasingly precarious financial institutions.
 
  • The South Korean government’s efforts to reorient the economy may be effective in the long term, but for now, the country remains heavily dependent on exports and will continue to be negatively impacted by the global exporters’ crisis for the foreseeable future.
 

Introduction
 

Multinational South Korean conglomerate Samsung recently made global headlines after announcing that it would recall and permanently end production of its popular Galaxy Note 7 phone due to a defect that caused the device to ignite and explode. The scandal is projected to have a serious impact on Samsung’s coffers. Losses and forgone sales could reach $17 billion, the impact of which is even more significant when considering that Samsung makes up roughly 20 percent of the entire South Korean economy.





A customer inquires about returning a Samsung Note 7 mobile phone at a Samsung store in a mall beneath the company's headquarters in the Gangnam district of Seoul on Oct. 12, 2016. Samsung Electronics slashed its third-quarter profit estimate by 33.3 percent, citing fallout from the recall nightmare surrounding its scrapped Galaxy Note 7 smartphone. ED JONES/AFP/Getty Images

Recent labor union protests have further signaled trouble for the South Korean economy. Workers at Hyundai Motor Company conducted a nationwide, full-day walkout in September, demanding wage increases. Though Hyundai workers have a fairly consistent track record of yearly protests, this was the largest strike in the company’s history and cost Hyundai an estimated $2.5 billion in lost revenue. The company’s operating profits fell an estimated 2.5 percent as a direct result of the strikes, and its quarterly net profits fell for the 10th consecutive time. Similar strikes by the Korean Public Service and Transport Workers’ Union have recently occurred. Furthermore, tens of thousands of protesters in Seoul rallied late last year against proposed changes to the country’s labor laws that would relax rigid standards for hiring and firing employees.

Samsung’s phone fiasco and the recent spate of labor union protests have called renewed attention to the overall status of the South Korean economy, the world’s 11th largest economy. Therefore, we thought it prudent to conduct our own re-evaluation of the South Korean economy in light of the aforementioned events and the global economic crisis that is underway.

Last year, we identified South Korea as
one of the top 10 victims of the global exporters’ crisis. Though the country’s annual GDP growth has remained positive, it has slowed in recent years; additionally, its exports have – with the exception of this August – fallen for 21 consecutive months. The South Korean economy has indeed been walloped by a variety of factors, both external and internal; the most impactful of these factors has been decreased demand from China, its largest customer.

With exports and, subsequently, economic growth continuing to decline, the South Korean government has attempted to prevent the country from entering a period of economic stagnation similar to Japan’s Lost Decade by making a number of changes. The majority of these changes focus on long-term economic reorientation and will require innovation and political maneuvering that is both time-consuming and challenging. Some of the proposed changes, however, are short-term Band-Aid solutions intended to keep sectors of the economy afloat.

Though the government may succeed in reorienting the South Korean economy towards new export markets and establishing a larger service economy, the current reality is that South Korea remains reliant on exports, particularly to China. Therefore, it is likely that South Korea’s economic slump will continue into the foreseeable future.


The South Korean Economy’s Current Standing
Exports, many of which are high-value-added products, make up close to half of South Korea’s economy. This high percentage of exports is anomalous among the countries of the Organisation for Economic Co-operation and Development (OECD), of which South Korea is a part.

South Korea consistently releases its monthly export numbers on the first business day of every month, thus providing reliable data by which to gauge the country’s economic performance. These monthly reports indicate that South Korea’s exports have been on the decline over the past 21 months, with August’s 2.6 percent rise (likely due to a temporary rebound in ship exports) as the only exception. Despite that brief bump, exports to China – which account for nearly a quarter of South Korea’s total exports – fell for the 15th straight month, down 9 percent year-over-year after a similar fall in exports to China last month.

South Korea's GDP Growth

The rate of South Korea’s economic growth, measured in GDP, is also falling. In 2014, the economy grew by 3.3 percent, and 2015 saw growth of 2.6 percent. However, despite weakening exports and Samsung’s recent catastrophe, the Bank of Korea expects the economy to reach its target rate of 2.8 percent growth by the end of 2016 (though this target was revised from its original 3.1 percent growth forecast). Both the International Monetary Fund and OECD have projected growth of 3 percent for the South Korean economy in 2017. However, forecasts from private research centers and think tanks are less optimistic, estimating growth in the range of 2.2-2.6 percent. These estimates are tied to slowing global growth. The World Trade Organization has slashed its global trade growth forecast for 2016 down to 1.7 percent and estimates a range of 1.8-3.1 percent for 2017, much of which is linked to decreased import growth in North America. Decreased global demand harms any exporting economy, but it presents a particular challenge to South Korea as its two largest customers, China and the United States, have both slowed their import consumption.

The reasons for South Korea’s decline in economic growth can be divided into two categories: external problems and internal challenges.

External Problems Facing the South Korean Economy


South Korea's Top 10 Trading Partners

South Korea’s largest external threat is its massive exposure to China, its largest trading partner, which accounts for approximately a quarter of its exports. Like the South Korean economy, the Chinese economy has also been weakened by reduced demand for its exports; this is a result of both structural slowdown and the 2008 global financial crisis. Its weakened economy has therefore reduced China’s consumption, which is one of the key elements that triggered the current exporters’ crisis affecting South Korea and other export-driven economies. The decreased Chinese demand for South Korean electronics, vehicles and machinery has caused a serious blow to the country’s economy.

South Korea has taken steps to reduce its future dependence on China by seeking alternative markets for its exports, particularly in the developing world. Here, South Korea is playing a long game. It has established a presence through participation in international organizations, aid-giving and diplomacy while simultaneously exporting its pop culture in the form of music and television to create a stable consumer market in the future. However, positive economic effects from this new consumer base will not be felt for some time yet; therefore, dependence on China will remain problematic for the foreseeable future.

In addition, the value of South Korea’s exports is declining at a steeper rate than the volume of its exports. This is largely due to currency devaluation in South Korea’s largest trading partners; the South Korean currency, the won, has strengthened while the Chinese yuan and Japanese yen have lost value. This makes Korean exports more expensive (especially to its largest importer, China) and puts already strained domestic producers at a disadvantage. Currency devaluation among its competitors makes South Korea’s exports less attractive to importers because they have become comparatively expensive. In particular, high-end Japanese products in the technology and manufacturing fields have become more appealing to importers as the cost of Korean products has increased. The South Korean government has introduced efforts to cut prices in an attempt to make exports more competitive, but this has decreased profitability and has not done much to spur export growth.

Furthermore, the global economic slowdown has impacted several of South Korea’s largest export industries. In particular, it has negatively affected South Korea’s refined petroleum and petrochemical industry, the country’s second largest export industry. Declining oil prices, which have been falling since June 2014, have slashed the value of South Korea’s petrochemical and refined petroleum exports. In 2013, South Korea reported $52.78 billion in refined oil exports, but the total value fell to $46.9 billion in 2014. By 2015, South Korea’s refined oil exports were only worth $30.7 billion.

The country’s fourth largest export industry, shipping and shipbuilding, is also hurting as decreases in global trade weaken the demand for shipping and low oil prices reduce demand for oil tankers. The three largest shipbuilders in the country – Hyundai Heavy Industries, Daewoo Shipbuilding & Marine Engineering and Samsung Heavy Industries – reported nearly $5 billion in combined losses in 2015 and have undergone massive layoffs to cut costs. Furthermore, major companies like Hanjin Shipping are at the brink of collapse. In an effort to reduce future damage and potential unrest, the government has stepped in, and on Oct. 31 announced a stimulus to the shipbuilding sector. The stimulus will include a government order for more than 250 ships by 2020, worth approximately 11 trillion won ($9.6 billion), 6.5 trillion won in fresh financing, 1.5 trillion won injected into the local economies of coastal cities that rely on the shipping industry, and plans for upping the profitability and global competitiveness of South Korean shipping companies and shipyards.

Another external threat to South Korea’s economy is the U.S. Federal Reserve’s interest hike in December 2015, the first such hike in nearly a decade; there is also a strong possibility of another hike in 2016. According to research published by the Korea Institute for International Economic Policy on Oct. 18, U.S. rate hikes will likely cause an exodus of foreign investment valued at approximately 3 trillion won over the next three months. As investors shift their money from South Korea to the U.S. to increase their returns, the South Korean economy will be negatively affected.

However, an additional rate hike would mean that the value of the dollar will strengthen against the won, giving South Korea the chance to increase its exports to the United States as its imports become comparatively cheaper — another step towards diversification away from China. Even so, U.S. imports are on the decline overall, and imports from South Korea are no exception. Despite rising consistently over the past decade, U.S. imports from South Korea for the first eight months of 2016 fell nearly 2 percent year-over-year, equivalent to $850.2 million. Thus, exports to the United States are not likely to dramatically jump as a result of a stronger dollar.

In addition to its attempts to mitigate the negative effects of the global exporters’ crisis, the South Korean government has actively encouraged growth of the country’s service economy since 2014. It is here, in the development of the service economy, that South Korea has the most opportunity for future growth. According to a report published by the Korea International Trade Association, South Korea’s service industry accounts for approximately 59 percent of the country’s total GDP – the smallest portion among major members of the OECD, where the average is 73 percent. South Korea’s service industry is dominated by small- and medium-sized enterprises (SMEs) and is inefficient compared to that of other OECD members, with productivity rates half those of the United States. Though South Korea has a considerable research and development budget, only roughly 3 percent is spent on the service industry. The major barriers to this transition are regulatory – the barriers to entry remain high and tight financial regulations make investment difficult. The government has announced plans to roll back regulations, increase funding for startups and cut the tax burden for service industries, but these changes have so far failed to yield significant results due to cultural barriers, political disagreement and the slow nature of change.


Internal Challenges Facing the South Korean Economy

 

Top 11 Economies by GDP, 2015

 
South Korea’s emphasis on manufacturing saw the country rise from poverty to the world’s 11th largest economy in the span of two generations. However, this created an over-reliance on manufacturing. In addition to being an external challenge, the reliance on manufacturing has led to serious internal structural challenges for South Korea.

The country’s major export industries are those that lend themselves to cost efficiency and consolidation, which has given rise to a group of large conglomerations, or “chaebols.” The top 10 chaebols – including Samsung, Hyundai and Lotte – make up an estimated 75-80 percent of South Korea’s economy. Downward pressure on wages has led to a recent string of protests, including a series of strikes at Hyundai that have put serious economic strains on the company and, subsequently, the entire South Korean economy. The chaebol-centric manufacturing industry has also stifled the growth of SMEs, which further promotes the country’s over-reliance on these conglomerations. Though the chaebols have certainly contributed a net positive to South Korea’s economy, their prominence and success have encouraged the development of an economic environment that is heavily dependent on manufacturing, and this further discourages the development of a service industry.

Here, the government is in a precarious position. The chaebols hold political sway, and South Korea must walk the line between the conglomerates and the public. To get money out of the chaebols’ coffers and back into the economy, the government has introduced a 10 percent tax penalty on excessive holdings. It has also promoted tax breaks for companies that use reserves to increase wages, investments and dividends. Additionally, to encourage the growth of the service industry and a healthier number of SMEs, the government has also moved to introduce legislation that will make it easier to promote good workers and fire poorly performing employees.

South Korea’s current workplace culture awards promotions and job security based on age and tenure rather than performance. The difficulty of firing poorly performing employees places a strain on productivity and efficiency, and it falsely inflates the country’s 4 percent unemployment rate. This low number masks the high percentage of part-time and contract workers in the South Korean economy (the result of companies being afraid to hire new employees). To achieve global-norm flexibility in hiring practices, the South Korean government has made moves to implement legislation that shifts workplace culture to reward performance over seniority, which was another cause for the protests at Hyundai and other corporations. South Korean trade unions are powerful and are often seen as militant. Continuing this path of legislative changes will likely provoke further public discontent, possibly even violence, which has made these changes a source of debate and disagreement within the government. Passing such legislation, however, would be a step towards greater efficiency and would help promote the growth of more SMEs.

For the last several years, South Korea has also been challenged by rapidly expanding levels of household debt, which threatens the economy by putting a damper on already slowing domestic consumption. In 2014, the government cut interest rates three times in an effort to boost domestic demand. Even so, South Korea’s total household debt rose to a record high of 1,060 trillion won in 2015. The ratio of debt to disposable income was approximately 160 percent. This is higher than the OECD average and, as many have pointed out, is similar to U.S. figures at the start of the subprime mortgage crisis.

The South Korean financial sector has grown in size, but it has also contributed less to the country’s GDP since the global financial crisis due to shrinking internal financial activities. According to a recent report published by the National Assembly Research Service, the financial industry accounted for only 4 percent of South Korea’s GDP in 2014 – a 1.2 percent drop from 2007. In April, Moody’s Investors Service reported that it would change its outlook on South Korea’s banking system from stable to negative, citing deteriorating creditworthiness over the next year and a half.  Precarious financial institutions become even more of a concern when considering the rapidly expanding levels of debt – if default rates begin to rise and the banks are not able to absorb the shock, South Korea could face a banking crisis, which would surely have a negative impact on its economy.
    
Conclusión

South Korea’s economy faces a host of internal and external threats. Though the largest of these are tied to the global exporters’ crisis, the current economic slump has also revealed a host of internal economic problems. These have manifested in political issues as the government works to make long-term readjustments while also providing short-term solutions to stimulate the economy. These efforts to address both long- and short-term problems have varied in success, but may indeed succeed in moving the South Korean economy away from its dependence on China and its over-reliance on the manufacturing economy.

In the past, South Korea has demonstrated economic resiliency and adaptability. This can, in part, be attributed to a political culture of discipline and swift action, which has historically been supported by its population. However, a successful transition remains a long way off. The shift to a service economy cannot happen overnight, and the South Korean government is already facing domestic pushback and political roadblocks to making the changes necessary for such a transition.

South Korea’s current economic reality is that of a manufacturing economy dependent on exports, which have been reduced by the exporters’ crisis and weak global demand. These problems have been compounded by internal structural issues, growing national and household debt and increasingly precarious financial institutions. As a result, it is likely that South Korea will continue to feel the squeeze of the global exporters’ crisis.

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