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South Korea faces Japan-like obstacles to growth

Trade-focused nation has further complications, such as a small domestic market, emerging competition from China, Taiwan

by Takashi Kitazume

Staff Writer

Even as leading South Korean firms outperform many of their Japanese rivals in the global market, the nation’s economy faces mounting challenges, including slowing growth, an aging population and widening rich-poor gap — problems that the country shares with Japan, researchers from South Korean think tanks said at a recent symposium in Tokyo.

South Korea’s industrial giants themselves need to find new business models to survive emerging competition from companies in China and Taiwan, which are catching up much faster than the pace of the Korean firms when they caught up with Western and Japanese rivals, they said.

The researchers from Seoul-based think tanks were speaking at a symposium organized Feb. 22 by the Keizai Koho Center under the theme “Korea, its industries and corporations in the global economy.”

Park Geun Hye, who took office as South Korea’s new president last month, devoted a major part of her inauguration speech to economic issues including commitments to the creation of jobs and expanded welfare.

Public criticism of the government’s growth-oriented policies mounted in last year’s presidential race as economic growth faltered in recent years and concern grew over income and wealth disparity, and the new Park administration will focus on the “quality” of growth rather than sheer growth numbers, said Lee Ji Pyeong, a senior research fellow at LG Economic Research Institute (LGERI).

Last year, the growth of South Korea’s economy, which relies as much as 60 percent on exports, slowed down even more than the global economy, Lee noted. Given the anticipated recovery this year in its major export markets including China, the United States and Southeast Asia, South Korea’s growth is forecast to pick up some speed, but not much, at around 3 percent, he said.

Still, a return to rapid growth of the past will be difficult over the medium to longer term, Lee said, as the country’s growth potential itself has declined to around 3 percent annually today. While the South Korean economy used to grow faster than the global average, it’s growth in the coming years will likely be kept lower than the worldwide trend, he noted.

One major factor is the demographics. South Korea, where the fertility rate is even lower and the population is aging more rapidly than in Japan, faces a decline in the working-age population, especially those in their 30s and 40s, Lee said.

A declining labor input will push down the nation’s growth potential — if labor productivity remains unchanged. South Korea’s potential growth rate, which was reported to be around 4 percent in the early 2000s, is forecast to fall short of 3 percent by 2020 and fall even below 2 percent in 2030, said Song Yeong Kwan, a fellow with the Korea Development Institute.

In South Korea’s case, labor productivity is fundamentally an issue with its service sector, Song said. Whereas productivity of the country’s manufacturing industries has improved sharply since the 1980s, productivity in the service sector has not risen much during the same period, he said. Behind this problem is the structure of the nation’s service industry, Song noted. While roughly 70 percent of the nation’s workers belong to the service sector, half of them work in low value-added businesses such as wholesale, retail, lodgings and restaurants, he said.

In addition to the productivity gap between manufacturing and services, there also is the wide disparity between big businesses and small and medium-size enterprises (SMEs), Song pointed out. Most of the productivity improvements by manufacturers over the past two decades came from major companies, which account for three quarters of the sector’s research and development spending, he said.

And while SMEs struggle to secure talented workers who are attracted to major firms, 40 percent of the nation’s workforce is hired by micro-businesses that employ up to four workers, Song said.

Huh Won Jea, a senior fellow at the Korea Economic Research Institute, observed how domestic demand in the country has been on a long-term downtrend. One of the reasons behind it is the slump in the real estate market and subsequent rise in household debts, which have reached a level equivalent to more than 90 percent of the country’s gross domestic product, he said.

Song of the Korea Development Institute noted that many of these structural problems are issues that South Korea has in common with Japan — perhaps partly because South Korea followed the Japanese model of economic development.

South Korea and Japan have room for more economic cooperation on both the government and private-sector levels, said Lee of LGERI. Responding to the aging population, for example, will require creation of new business and industrial models, and it’s one area where the two nations can work together, he said.

While free trade talks between Japan and South Korea have not progressed much, the two countries can expand their cooperation on regional issues to help realize Asia’s growth potential, Lee said.

South Korea’s aggressive policy for free trade agreements has been a reflection of the slowing growth of the domestic economy since the 1990s, noted Suh Jin Kyo of the Korea Institute for International Economic Policy.

Unlike Japan, South Korea has a small domestic market and relies much more heavily on trade, and the government sought FTAs as a way out of the domestic woes, Suh said. In addition to its attempt to make South Korean firms more productive through international competition, the government also wanted to use FTAs as a tool for structural reforms at home, he said.

So far, South Korea has concluded eight FTAs, including with the U.S. and the European Union, that cover a total of 45 countries, he said. Those countries account for 35 percent of South Korea’s overall trade, and the government’s target is to ultimately conclude FTAs that cover 80 percent of the nation’s trade, he noted.

As in Japan, agricultural lobbies strongly resisted these free trade arrangements, and the government promised massive compensation in case farm product prices plummeted as a result of increased imports. But so far, prices of domestic farm products have basically not come down despite the FTAs, Suh said.

The small size of the domestic market has in fact been a factor in today’s success of leading South Korean firms like Samsung, said Lee Yong Hwa of the Samsung Economic Research Institute (SERI).

Japanese automakers and electronics makers may spend so much time and energy on fierce competition in the domestic market, but major South Korean firms concentrate on the much larger overseas markets, Lee said. Because they have to explore the markets abroad, they don’t care about domestic standards or features but try to absorb and digest the global standards as quickly as possible, he said.

With its small domestic market unable to absorb shocks from external factors, the South Korean economy has been exposed to a series of major crises since the late 1990s, ranging from the 1997-98 Asian financial crisis to the crisis spurred by the 2008 collapse of Lehman Brothers, he noted. That repeated sense of crisis forced South Korean firms to be constantly on guard for change and be ready for structural reforms, Lee said.

Still, the currently robust South Korean giants face various risks ahead, he said. One is that those Korean firms — who caught up with Western and Japanese rivals by learning from their ways in the 1990s — can repeat the same mistakes of the competitors in advanced economies, he said. Many South Korean firms still rely on hardware in their international competition, he said, adding that they remain weak in terms of design, contents, software and platforms.

Another major threat comes from China and Taiwan, Lee said.

In the global smartphone market in 2012, Samsung was trailed by China’s Lenovo Corp., which doubled its market share from only two years ago to 10.4 percent, he said, noting that Lenovo is forecast to take the top share in 2013. Much of the tablet computers sold worldwide today are made in the Chinese plants of Taiwanese electronics firms, he noted.

Chinese firms have learned from the formula of success of South Korean companies, and they are catching up fast, Lee said. In the past, South Korea learned from Japan’s industrial success twice as fast as Japan, but Chinese are even faster, he said.

And this becomes an even greater threat when you consider the trap of today’s technological innovation — especially in the information technology sectors where the South Korean firms have the competitive edge now — in which products like smartphones will be more or less the same no matter who makes the products and it’s getting increasingly hard to differentiate from competitors, Lee said.