[ Economy > Focus ]

he Korean economy has achieved outstanding results in recent years and is fingered to be the top performer in the Organization of Economic Cooperation and Development (OECD) in 2003. (See box)
  In particular, the OECD noted the economy¡¯s recovery in 2002 reflects the success of its economic restructuring program and the underlying dynamism of the economy. However, in spite of this impressive turnabout, there is anxiety abroad about the Korean economy as a result of three main factors: reduced growth potential, the nuclear threat posed by North Korea and instability of the financial market. The slump in investment and consumer spending are complementary factors.
  By far, the largest economic challenge faced by the new government is the decline of its growth potential due to stagnating investment. Speculation abounds as to whether the growth pattern that propelled the country into industrialization has finally reached its limits.

   FAIRER COMPETITION While facility investment has been on the decline for two years, there are fears of a ¡°hollowing-out¡± of manufacturing industry as more and more companies turn to China for outsourcing. Further, the aging population in combination with the five-day workweek may result in a significant reduction of the economy¡¯s labor input.

  On an international scale, competitive pressure is intensifying from the trend toward trade liberalization and regional economic blocs. More specifically, Chinese industry is rapidly catching up with Korea in the country¡¯s core industries after closing the technological gap in light manufacturing, At the same time, Korea has so far been unable to seize the technological lead established by more advanced nations.
  There is no short-term solution to the competitive weakness in the manufacturing sector. In light of this given, the newly launched ¡°Participatory Government¡± of President Roh Moo-Hyun is opting for medium to longterm remedies to promote more efficient and fairer competition through market reform with the ultimate goal of heightening national growth potential.
  Others include the project to elevate Korea to the position of an economic and business hub of Northeast Asia, attracting high-quality scientific/technological personnel together with advanced technology and creating an optimal business environment.

   MICRO-ECONOMY BENEFITS As a part of its hub project, the government will likely designate Incheon International Airport, plus the port cities of Busan and Gwangyang during the second half of this year as Economic Free Zones. The zones will, in fact, function as micro-economies where special laws will apply and foreign investors will enjoy particular benefits. In order to enable it to compete with other Asian airports in handling additional volume, the long-term program for the expansion of Incheon will continue, while massive infrastructure investments will be made at Busan and Gwangyang Ports. Foreign investors moving into the zones will benefit from generous tax breaks. (See ¡°Where to Invest¡±).
  Further support measures for foreign investing firms such as a simplified tax system and an even further reduced tax burden for locating companies are under active consideration. These moves are testimony to the Korean government¡¯s commitment to creating the most business-friendly business climate in East Asia. In tandem with these projects, the government recognizes the crucial importance of spurring technological development, and promoting the efficiency of research and development expenditure. Korean business competitiveness is, in other words, judged a prerequisite for the national economy to attain world-level competitiveness.
  A consensus now is growing that Korea must once again apply the lessons of the 1997 crisis and continue its restructuring efforts to meet global standards. The effort to heighten management and accounting transparency to build investor trust as the premier condition necessary to make Korea a more competitive business destination has broad support throughout government and the corporate sector.

   DEALING WITH THE NORTH A major destabilizing element in South Korea¡¯s drive to foster greater economic well-being is North Korea¡¯s nuclear weapons program. The nuclear threat from the North serves to discount the achievements of South Korea in the eyes of the world. Therefore, without a solution to the crisis, there can be no assurances for the long-term growth of the South Korean economy.
  The issue of North Korea¡¯s nuclear program, smoldering since late last year, now occupies the world¡¯s attention following the conclusion of the war in Iraq. With both North Korea and the United States entrenched in their respective positions, it is unlikely that a conclusion can be reached to the satisfaction of both parties in the near future. However, an all-out confrontation does not appear likely since the cost would be too heavy to bear for either side. In fact, with the U.S. presidential election looming, some form of deal may well be made before the end of the first half of 2004. Also, from the North Korean point of view, if its regime can obtain a guarantee of survival from the United States, it would clearly be the wisest option for it to pursue.

   THE POWER OF PERCEPTION From a cursory perusal of the foreign press, there would appear to be a difference of chasmic proportions between the way South Koreans perceive the North Korean nuclear threat and the way it is perceived elsewhere in the world, particularly in the United States. Many in South Korea are firmly persuaded that there can and should be a peaceful solution to end North Korea¡¯s nuclear weapons development program. Realizing the destitute state of their brethren to the North and the paranoia of their leadership, South Koreans know full well and better than any one else why North Korea is trying so desperately to bring the United States to the negotiating table. Unfortunately, foreign investors and press do not share this same grasp of the situation and the resultant incomprehension appears to heighten anxieties.

  Consequently, the South Korean government is taking a number of diplomatic steps to narrow this perception gap. The South Korea/United States summit meeting convened in May, for example, confirmed that their alliance is alive and well and that the two nations were united in their intent to bring a peaceful end to the nuclear crisis triggered by the North. The upcoming South Korea/Japan and South Korea/China summit meetings will further advance South Korea¡¯s cause of peacefully concluding the crisis.

   VISION OF NORTH/SOUTH MUTUAL PROSPERITY The Korean government¡¯s stance toward the North¡¯s nuclear weapons development may be summarized in the following three points:

The Korean government shall not tolerate or condone nuclear arms on the
   Korean Peninsula in any form or fashion
North Korea must be disarmed through peaceful means
To this end, South Korea shall negotiate with North Korea from a joint
   front constituted by the South Korean/U.S. alliance, and neighboring
   countries including Japan, China and Russia
  The Korean government is confident that the nuclear crisis will be resolved satisfactorily in the foreseeable future. In spite of lingering uncertainty about whatever tactics it might employ, the government is holding out a vision of a greater Korean economy to the North in which it can participate for the betterment of mutual prosperity. Another major factor worrying prospective foreign investors is the transparency of Korean companies and markets, brought into question by the breaking of the SK Global window-dressing fraud and the resulting instability of local financial markets.

   SK - A CHANCE TO CLEAN HOUSEThe SK Global affair proved to have expensive consequences. Its impact has extended far beyond simple financial losses incurred by banks, creditor groups and shareholders by casting doubt on the soundness of the Korean corporate structure that has been rebuilt since the currency crisis. It can only compare to the Enron debacle in terms of the turmoil and shock generated in Korea. To make a virtue out of a necessity, government has seized on the affair as means of demonstrating to investors its seriousness about punishing those who would produce fraudulent statements and as an opportunity to strengthen its market monitoring and surveillance practices to eradicate the possibility of similar frauds occurring in the future. Paradoxically, the fraud will serve as a wakeup call for the corporate world, adding momentum to Korea¡¯s ongoing drive to foster a management culture characterized by greater transparency and hastening the introduction of measures to promote corporate integrity such as class action suites.

  The fraud and ensuing scandal will also provide the impetus for the chaebol to remodel their ownership/control structures. For example, although the largest shareholders of SK Group affiliates hold relatively small amounts of equity, they have close to 50-percent control of SK C&C that acts as the holding company for the group. The government, for its part, is introducing support legislation with all due haste. Class action suits, in particular, are expected to curb irresponsible and arbitrary management decisions.

   COMBATTING UNDERPERFORMANCE On the other hand, the scandal not only triggered instability in Korea¡¯s financial market; it also stoked anxieties about the solvency of credit card companies given the mounting level of delinquency. In mid-March the credit card companies faced a surge in money market fund redemptions and repurchase requests, threatening a liquidity crisis that was only brought under control by rapid government intervention and issuance of credit-card bonds by investment trust firms. However, the growing delinquency rate fuels misgivings about the ability of the card companies to control their clients¡¯ debt compliance. From a mere 2.5 percent at end-2001, the rate climbed to 6.6 percent late last year, and to 10.9 percent by April 2003.
  Steering the economy out of the present slump is another urgent task at hand for Korea. Elements of unrest from within and outside the country and uncertainty about the economy are multiplying. Inevitably, physical indicators are plummeting along with psychological indicators; the country¡¯s index of leading macro-economic indicators has trended downwards for 12 consecutive months to the end of April.
  Consequently, it is doubtful that the 5.8-percent expansion in GDP projected by the OECD for this year will be met, and growth expectations have been downgraded domestically to the 4-percent level. Although this is much higher than any other OECD country, as Korea¡¯s potential growth rate is estimated at 5 percent, 4-percent growth may be assessed as an underperformance. Furthermore, the deterioration of trade conditions including the softening of export prices is reflected in the decline in Gross National Income (GNI), recorded during the first quarter. Consumer sentiment, therefore, may be hit worse than during the 2001 recession.

   TRADE, CORPORATE EARNINGS HIT HIGHS The government is responding to the economic slowdown through macro-economic policy to effect longterm change, while applying micro-economic strategies in the short term to curb the downward slide in economic fundamentals and thereby achieve a recovery during the second half of the year.
  One of the brighter spots in the Korean economic picture is international trade. First quarter exports were up 20 percent on the year while those to China in particular leapt by 70 percent. Exports for the month of April established a record at $15.86 billion, a reflection of the continued upswing in outbound shipments of IT systems and automobiles. The recent decline in trade profitability is largely attributable to high oil prices; Korea¡¯s oil import bill is climbing every month by $700 million. Despite the low level of consuption and facility investment, corporate earnings hit their highest-recorded level in 2002 while banks now earn over 5 trillion won annually on aggregate. The corporate debt ratio has dropped from a staggering 400 percent in 1997 to the 100-percent to 150-percent range as of end of last year. Korea¡¯s foreign reserves soared from less than $4 billion in December 1997 to more than $120 billion this year, the world¡¯s fourth largest.

   RESPONSES TO UNCERTAINTY Most importantly, Korean corporations have reformed their management styles and structures since the crisis and now place priority on protecting the interests of shareholders and maintaining the goodwill of their foreign investors.
  In the face of growing global economic uncertainty, the Korean government is preparing various response scenarios. Each scenario is accompanied by a strategic contingency plan and a detailed economic policy to be implemented in concert with relevant governmental economic agencies. To provide itself with financial leeway to effect short-term measures, the government reallocated part of the budget for the second half of 2003 to the first half. It has also created a supplementary 5-trillion won economic budget to intervene in order to prevent further deterioration of the economy. Together with a call rate cut of 0.25 percent by the Bank of Korea in May, the road to a second-half recovery is thus being paved.
  Korea is a model economy and has won the admiration of the world at large, growing at a rate not only faster than the advanced countries but also the developing nations of Asia. In order to become a full-fledged member of the advanced nations, Korea still must overcome several challenges in addition to the immediate concerns represented by the afore-mentioned destabilizing factors. Korea is facing the double mission of successfully globalizing its economy and positioning itself as a nation vested with a worldclass technological base. How to cope with its rapidly aging society and exploit the economic potential of the burgeoning Chinese market on its doorstep also present additional yet no less crucial tasks. While challenges are thus real and manifold, the prognosis for Korea¡¯s economy is far from somber, especially if we have faith in the resourcefulness that her people have demonstrated in all areas of economic endeavor over the past 40 years.

by Gim Gi-Seun (gs-kim@lgeri.co.kr)
LG Economic Research Institute