South Faces Bleak Economic Future

There is growing concern about South Korea's economy and political situation, according to a new report by Asianomics, the Hong Kong-based financial research firm. Thunderclouds are forming and waves are building, according to the report, written by deputy chief economist Sharmilla Whelan.

Following an initial growth in the wake the Global Financial Crisis that began in 2008, the economy has been slowing steadily, according to the report, titled Korea: Brewing Storm, which is available only to Asianomics clients. Consumption growth almost halved in in the first quarter of this year, while gross fixed capital formation has has contracted in six of the last seven quarters as Korea's economic fortunes have become intimately tied to her export performance.

"All key macroeconomic indicators are trending down. Now add to this Japan's yen debasement policy, and the writing is clearly on the wall," Whelan writes. "As it stands our analysis of Korea in the profit and credit cycles renders her at the bottom of the rankings in Asia…Companies are over- leveraged. Profitability is declining. Solvency is deteriorating. Corporate balance sheets are in tatters and households are tightening their budgets. Consequently even though capital is being priced appropriately, there is little demand to borrow."

Beyond that, Korea's problems suggest that the current slowdown could be more than cyclical. Government policy is taking a worrying direction.

In a political overview written by Asia Sentinel's Steven Borowiec, he points out that Park Geun-hye campaigned for the presidency in the December 2012 elections under the slogan of "economic democratization," promising to level the economic playing field and address the country's rising income inequality.

Park's Saenuri Party, which went on to win a majority in the National Assembly, pledged: "to realize a fair-competition economy that protects the market, small and mid-sized businesses and consumers from mammoth economic forces."

While creating a level playing field is desirable, unfortunately under strong public pressure the Park government is increasingly threatening to use economic democratization to curtail labor-market flexibility, increase protection for Korea's small and medium enterprise sector, restrict market entry for large companies and further regulate the chaebol, Korea's economically and politically powerful conglomerates.

"The changes already wrought in the name of economic democratization are worrying," the report notes. "Furthermore, economic democratization could not come at a worse time…Corporate median debt and operating cash flows for 2012 came in at the worst in Asia and the worst in Korea for more than a decade. Median profits have contracted by 32 percent between 2010 and 2012 while companies have recorded free cash outflows of 3-4 percent of profits for two consecutive years."

Internal contradictions are growing. Korea's chaebol still have their problems, including weak governance, family-controlled decision-making, cross-subsidization of group companies, and monopolistic tendencies.

The report, however, argues that the chaebol have come a long way since the Asian Crisis of 1997-1998, with foreign ownership of shares rising and the chaebol themselves becoming increasingly global players, with global shareholders to keep their ambitions in check. They have had no choice but to become more competitive and more focused on delivering returns to investors. Moreover, they have learned from their past mistakes.

Thus today it isn't the chaebol but the highly protected SME sector and the distorted labor market where the real problems lie, Whelan says.

Korea's SMEs, the report continues, "are inherently inefficient and plagued by low productivity. For example, productivity in services, where SMEs dominate (80 percent of output and 90 percent of employment), was only 53 percent of Korea's manufacturing sectors in 2008 - coming well below the OECD average of 87 percent.

Unsurprisingly, since the trough of the global financial crisis, service sector value added - as measured in the national accounts - has risen by 12 percent compared with 42 percent for manufacturing. The government's misguided protectionist policies mean that SMEs, unlike the chaebol, have not been forced to restructure and become competitive.

And then there is Korea's distorted labor market. Temporary workers account for 27 percent of employment, which is not high by OECD standards. Koreans, however, are complaining about this as well as the fact that there is a widening wage gap between regular and non-regular workers.

But at the root of the problem is the skills gap between the two sets of workers which is manifesting itself in a yawning productivity gap. Hence, when temporary worker wages are adjusted for differences in gender, education, occupation and age, the gap narrows to 13 percent.

Significantly, the report continues, sectors and firms blighted by low productivity growth - notably the construction, retail and wholesale sectors and firms with staff numbers below 300 - have higher levels of temporary workers.

If anyone is responsible for the plight of temporary workers it is the government, which has not invested in the right sort of education and training programs. Companies in the meantime - faced with stringent labor laws and powerful trade unions - have had no choice but to rely on costly early-retirement packages or on employing temporary workers to manage costs.

"We see economic democratization, if adopted along the lines currently being discussed, as having disastrous consequences that will go beyond the current cycle and permanently damage Korea's competitiveness."