Growth in the economy has slowed to 4 percent, but the stock market has risen eightfold in dollar terms since bottoming out in 1998. South Korea is the only East Asian emerging market to have hit all-time highs since the financial crisis. Korean conglomerates now understand the importance of adding economic value by investing extensively in research and development; the country’s R&D expenditure as a share of the economy is one of the highest in the world, at 2.6 percent of its gross domestic product. The focus on investing in technology and building global brands now distinguishes Korean companies from Asian counterparts that are still stuck in low-margin contract-manufacturing businesses. Once again, however, the rise of Korea Inc., to the exclusion of the rest of the economy, could end up being problematic.
First, the good news. South Korea has been one of the largest recipients of foreign portfolio flows in the current emerging-market bull run, even though its economy hasn’t participated in the boom. Korean conglomerates have become growth plays, and are benefiting from their pioneering moves into fast-growing markets like China and India. South Korea’s economy is even more closely interlinked with China than with the United States. A furious pace of outsourcing by South Korean companies has also helped raise the rate of overseas investment as a percentage of Korea’s GDP to 7 percent.
But herein lies the problem. It seems the only way to succeed is to go abroad, and not just for corporate jobs. The ratio of domestic fixed investment to GDP is falling. Angst is rising at home as jobs move abroad. The country is running a deficit of $20 billion a year in its service sector as Koreans venture out in huge numbers, seeking better education and health care.
For a country fast approaching a per capita income of $20,000, Korea’s sclerotic service sector is a major anomaly. It may explain why domestic trend growth has slowed so sharply. While one can argue that it’s natural for growth to decelerate as the economy approaches a high per capita income, there’s no reason that Korea can’t grow at 5 to 6 percent. Indeed, Japan, Singapore and Hong Kong did expand at such a pace at similar stages of development.
But to achieve that, Korea needs to lighten its heavy dependence on manufacturing. The service sector accounts for 52 percent of Korea’s GDP, compared with 70 percent in most developed countries. That is a serious impediment to the country’s goal of becoming a financial hub of East Asia. A large manufacturing sector has also led to widespread underemployment, as big producers streamline costs to remain globally competitive.
The service sector isn’t large or productive enough to pick up the slack. The current government has done little to cut the extensive regulation choking the sector. Productivity in services is half that in manufacturing, as the government continues to interfere in areas ranging from pricing of key utilities to maintaining a monopoly in a poorly run education system. To increase the competitiveness of the service sector, the government needs to expose it to more foreign competition, just as it did in the manufacturing sector after the Asian financial crisis.
South Korea’s experience of the 1980s and ’90s showed that there is a limit to how far a country can sustain a disconnect between economic and corporate performance. In fact, the two variables are highly correlated in the current emerging-market cycle; in countries like India and Russia, economic and equity-market behaviorshows that the economy and the stock market can indeed be Siamese twins.
For its part, South Korea has gone from one growth extreme to another. Now the slowing domestic economy is producing a rise in antiforeign sentiment, and increasing discontent over underemployment. Policymakers urgently need to fix the disparity before it’s too late.
