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Behind the crisis in South Korea's economy
By David Scofield

It's hard to imagine that an economy, any economy, growing at 5% per annum is actually in crisis, but so it is in South Korea. On the positive side, exports have never been stronger. South Korea's exporters can't produce fast enough to fill global (read: Chinese) demand. These exports are maintaining the economy and fueling the growth on which the South Korean economy depends. But while export growth is keeping the country out of recession, domestic consumption is flat, and with Korea's consumers keeping their wallets closed, short-to-mid-term economic strength seems unlikely.

On the surface, the situation seems reminiscent of 1990s Japan: strong export growth coupled with a receding domestic economy. Unlike Japan's consumers, who chose to keep their savings safely locked away, rebuffing government attempts to lure them to spend, South Korea's consumers have severely curtailed spending as a direct result of debt.

South Korean households went from being largely debt-free in 1997 to holding an average of US$27,000 in debt per household in less than six years. Almost 4 million Koreans have defaulted on credit-card debt and household loans, a figure representing close to 10% of the country's population. The key indicator of how Korea's households are fairing is not found in housing prices or new-car sales, but private education expenses. A Korean household will forestall the purchase of a new car or delay purchasing a new house during lean times, but nothing short of calamity can dissuade Korean families from spending whatever they can muster on private tutoring for their children. Yet spending on this national staple was down almost 10% year on year in May, an indication of just how tight things are for Korean families.

South Korea's lack of domestic consumption is not about to turn around. Further, the attempts by the administration of President Roh Moo-hyun to create the perception of an economic recovery by changing the way statistics are calculated - moving from a year-on-year to month-on-month comparison - a change that will "create" a statistical bounce in the fourth quarter as exports are traditionally strongest in this quarter, are not going to change the fundamental reason behind the drop in consumer sentiment and spending. Koreans are deeply in hock and short-term fixes and window dressing with statistics are not going to change that.

The South Korean economy is in essence running on one cylinder, exports, but even here the future does not necessarily look bright. The Chinese economy keeps steaming ahead, and as such is absorbing South Korean exports at a record pace, but this may not be the case indefinitely. Chinese economic officials have indicated they are very concerned with the negative consequences of an overheated economy and, it seems, the political fallout of a feared economic bubble-burst in the world's most populous country, increasingly fissured as it is between the "gold coast" haves and the "hinterland" have-nots. Strong government curbs on growth in China could dramatically slow Korean exports, sending the South Korean economy into a nosedive.

China's economy does not complement Korea's
Further, China's economy does not complement South Korea's; rather it represents a strong near-term competitor to Korea's most lucrative export industries: chips, ships, cars, phones and peripherals. The technology gap between China and South Korea is small and closing fast, with Korea's National Science and Technology Council indicating that the Chinese are at most only five years away from realizing technological parity with South Korea, and head and shoulders ahead of Korea in terms of wage competitiveness, a primary factor in the growing exodus of small, medium and large Korean companies abandoning expensive Korean labor in favor of China's tightly controlled state unions and highly cost-effective labor environment. Today, 30% of products made by South Korean companies in China are exported back to South Korea. A recent survey by the Federation of Korean Industries, a corporate lobby group composed of Korea's largest firms, shows that nearly half of all South Korean firms that have invested in China plan to increase their investment over the next five years, while further curtailing investment in Korea.

Nevertheless, South Korean exports are strong and, while China is a wild card in terms of export growth, Korean firms have made substantial headway in establishing their brands in lucrative European and American markets. But while South Korea's exports seem set to remain strong for the foreseeable future, the direct benefits to the Korean economy from these exports are far less than they used to be.

South Korea grew from the ashes of the Korean War 50 years ago to become the 11th-largest trading nation on the back of strong exports and a closed domestic economy. Households saved. The banks lent these savings to what are today Korea's largest firms, operating in key export industries. But in contrast to past practice, Korea's high-tech export industry is driven largely by technological efficiencies: machines, not people. Thus while exports, and by extension the economy, continue to grow, the positive effects in terms of facility investment and employment are decreasing. Today, Korea's export industries are employing only a third the number of people they retained a decade ago.

All of this is natural, of course. As economies develop and export focus moves to higher-value-added products in highly competitive markets, domestic economies must shift from a strict reliance on exports to the development of the local economy, services and consumption. However, shortsighted consumption policies initiated by the administration of former president Kim Dae-jung encouraged reckless allocation of credit with little regard to risk. The banks understood the former administrations's desire to use easy credit as a way to pull the country out of the 1998 economic crisis; they played their part all to well, proffering credit to virtually anybody.

The Korean Board of Audit and Inspection reported on Friday that irregularities within the credit-card sector included 4.3 million cards issued to more than 1.8 million people with no or negligible incomes. The effect has been more than $375 billion in household debt, and almost 10% of the country being in default. A recent report by Morgan Stanley indicates the household debt in South Korea has reached 117% of household income, nearly 75% of the nation's gross domestic product. Programs designed to sop up this unserviced debt through direct and indirect government initiatives such as the Bad Bank and Harmony Co have so far written down debt and proffered soft loans to about 300,000 bad creditors, less than 10% of South Korea's credit delinquents.

There is blame enough to go around: shortsighted government policies; banks allocating credit with little concern for risk; consumers, many with meager incomes, accruing debt far beyond their means to repay - all are part of the problem. Credit-recovery programs, soft loans and other initiatives have greatly stemmed the growth of bad debt in South Korea, but there's a long way to go, and a mountain of public money to mobilize before the tide reverses, confidence returns to Korea's consumers and sustainable growth emerges within the domestic economy.

David Scofield, former lecturer at the Graduate Institute of Peace Studies, Kyung Hee University, is currently conducting post-graduate research at the School of East Asian Studies, University of Sheffield, United Kingdom.

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Jul 20, 2004



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