Daniel Melser

By Daniel Melser
Senior Economist, Moody's Economy.com

Korea continued to impress in 2007. Many forecasters, including Moody's Economy.com, have been surprised at just how well the Korean economy has performed so far this year.

More than anything else, the country's recent success has been a result of an apparently unending stream of export revenues. Korea's Inc. has continued selling to the world despite the currency reaching its highest point in a decade, an overall easing in global demand compared with a couple of years ago, and stiff competition in international markets.

Trade has been vital to the overall success of Korea's economy. It has partly been the battles, hard-fought and won, in global markets that have seen the country rise up the international income rankings. To continue this ascent up the global rankings, some of the lessons learnt in the export sector need to be applied to the rest of the economy. While growth in trade has surged the services sector ― everything from real estate, to healthcare and retailing ― has been slower to move forward. This is important as the future for Korea lies less in the production and export of hard goods ― which will eventually be more cheaply produced in emerging markets ― and more so in the supply of soft services ― research, development, management, entertainment and consultancy.

Transforming the Economy

The transition to a ``knowledge economy'' is firmly underway in Korea. Both the government and the private sectors are keen to reinvent the economy as a niche services provider in the North Asian region. The most recent moves in this regard have seen a so-called ``big bang'' of financial sector deregulation. The goals are lofty; to see an increasing amount of Asia's pension and investment funds managed out of Seoul thus boosting services exports. The moves are a clear step in the right direction and will help build more robust capital markets and develop greater investment banking capacity.

Reforms are needed across a wider range of areas in the coming years. Along with the financial sector, other areas where productivity has lagged overall growth, and which urgently need to be brought up to speed, are real estate, retailing, health, public administration and education, among others. As the authorities gradually move to reform these sectors, both the direction and style of change can draw upon the uniquely Korean mode of economic development. In particular there are important lessons to be learned from the continued very strong performance of the tradeables sector. This sector remains the most productive and successful facet of the Korean economy.



Made in Korea

Korea's exporters have come a long way in a very short time. These days, the ``Made in Korea'' label is more likely to appear on the latest electronic gadget rather than a t-shirt, toy truck or plastic bucket, as in years gone by. The ability of the tradables sector to shift up the value chain has been one of the secrets of the sector's, and the nation's, success.

Korea is now a world leader in high-tech consumer electronics with big global brands such as LG and Samsung based on the peninsula but calling the world home. These conglomerates are major global suppliers of everything from mobile phones to memory chips, laptops and refrigerators. The country also has global clout in shipbuilding, where Hyundai is world number one, and autos where the company has an increasing presence.

It was no accident that these conglomerates have been so successful. In electronics it reflects the willingness of the population to adopt and adapt to new technologies. Korea has a first-rate IT infrastructure, leading the world in broadband uptake, as well as tech savvy consumers, making it the ultimate testing ground for new high tech devices. In pushing forward reform it will be important to focus on areas where the country has a natural advantage or can leverage off existing strengths.



Big is Beautiful

Korea's global players have also benefited from their sheer size and dominance of the domestic market. This has enabled them to focus on the longer term ― investing in research, development and branding ― rather than being constrained by short term profitability worries.

The ``size-does-matter'' lesson is an important one. The Korean economy is currently characterized by a disproportionate number of small-and medium-sized enterprises. These businesses struggle to operate at an efficient scale and consequently have difficulty in turning a profit. Going forward, some consolidation of these enterprises may be required.



The Benefits of Globalization

The globalization of production and consumption has been of significant benefit to some of the country's successful exporters. Many have taken advantage of the increasing internationalization of the production process by integrating into global supply chains. This has enabled them to source inputs where they are most efficiently provided. The standard recipe is for design and development to be undertaken at home, to base manufacturing in China and undertake marketing and sales in the destination markets.

Much of the recent gains in Korean trade have been in the processing trade and the ingenuity of the country's entrepreneurs to leverage off Chinese growth. The more technologically sophisticated components are made at home and are then often sent to China for assembly. Developed markets in North America and Europe, remain the main final destinations.

This triangular trade has surged as China has become increasingly integrated into the global economy. China has sucked in ever-greater amounts of components as it continues to build factories. Without the tech know-how to make some of the most sophisticated gadgets, the mainland has been increasingly reliant on Korea for these inputs. China overtook the U.S. as Korea's largest export market in 2003 and now absorbs 24 percent of total exports compared with close to 10 percent each for the U.S. and Europe. Ongoing growth in Chinese purchasing power will likely see this market become even more important to the Korean economy.

Opportunity Knocks

The country already has a strong foothold in the Chinese market. This provides an ideal launching pad for many of the global ambitious services sector, such as the finance and the entertainment industry.

The global market, and foreign competition, is not something to be feared. Instead it represents an opportunity to source inputs more cheaply or to expand and grow markets. Currently, many services industries in Korea remain cordoned off from foreign competition. While the recent free trade agreement with the U.S. saw some areas opened up to competition - accountancy, finance, and legal services - the great swathe of public services, health, education, entertainment and much else beside, were off limits.

In the years ahead the authorities must kick off a succession of ``big bangs'' right across the Korean economy. The lessons of Korea's past successes provide some insight into the way forward. And the timing could not be better, successful local firms have what will soon be the world's biggest market ― China ― at their doorstep.