Korea faces manufacturing exodus

Unfriendly environment, tariffs forcing firms to go abroad

By Kim Jae-kyoung

Korea is facing a massive outflow of major local manufacturers as they are rushing to expand overseas investments and build new factories abroad.

This is in response to the government's unfriendly business policies coupled with rising tariff pressure caused by U.S. President Donald Trump's protectionist measures.

Given rising labor costs and a deepening trade war between the U.S. and China, it is highly likely this trend will accelerate, further reducing jobs here and hurting Asia's fourth-largest economy.

“Korean firms have invested in foreign locations to be closer to markets, overcome protectionism and cope with higher costs in Korea,” Mauro Guillen, director of the Lauder Institute at the University of Pennsylvania's Wharton School, told The Korea Times.

“At the present time these forces have become stronger and therefore much more salient for Korean firms. It is not surprising they are stepping up investments abroad.”

Troy Stangarone, senior director at the Korea Economic Institute (KEI), said Korean foreign direct investment (FDI) into the U.S. grew at a rapid rate in response to concerns about Trump's trade policies.

“It's perhaps too early to consider this a trend, but for the foreseeable future, firms are likely to face an uncertain economic environment as the Trump administration pursues its trade war with China,” he said.

“Firms will face incentives to move production to either China or the U.S. the longer the conflict takes place.”

According to the Export-Import Bank of Korea, Korean manufacturers' overseas investments jumped by 65.5 percent in the first quarter of 2018, a dramatic rise from the previous year's 27.8 percent contraction.

This is comparable to the nation's whole industry that saw its combined investments abroad decrease by 28.2 percent during the same period. It grew 6.14 percent a year ago.

Against global trends

These downbeat statistics came as the result of conglomerates' move toward “offshoring,” the relocation of their production facilities abroad.

In May, Hanwha Q Cells signed a memorandum of understanding with Whitfield County, Georgia, to build a solar module manufacturing plant worth 165 billion won. Construction will begin in 2018, and the facility is scheduled to be completed in 2019.

Hyundai Motor has decided to invest 420 billion won ($388 million) to increase production capacity at its factory in the U.S. state of Alabama.

Samsung Electronics spent 400 billion won to build a washing machine factory in the U.S., which began operation in January. LG Electronics also invested 270 billion won to construct a home appliance factory in the U.S.

“Offshoring is a hard trend to avoid given that firms are trying to stay on the front foot and profitable, so long term it makes sense to move abroad where operating costs can be lower,” said Katrina Ell, economist at Moody's Analytics.

Manufacturing firms' overseas expansion has dealt a blow to the domestic job market.

According to Statistics Korea, the manufacturing sector shed 126,000 jobs in June, the biggest drop in 17 months since it cut 170,000 jobs in January 2017. Manufacturing lost 79,000 jobs in May.

What is of more concern is that this is not a passing phenomenon but a structural issue.

According to a report released by the Korea Institute for Industrial Economics and Trade, the manufacturing operation rate fell to 71 percent in the first quarter, the lowest since the 2008-2009 financial crisis. This means three in 10 factories stopped running.

This runs against global trends. The comparable rates for Britain and Germany, which fell to 73.3 percent and 73.6 percent, respectively, during the financial crisis, have rebounded recently to 81.1 percent and 85 percent.

“Manufacturing is the backbone of the Korean economy. The relatively rapid rise of factories setting up abroad due to more favorable operating environments including lower labor costs will hurt incomes, employment and consumption back in South Korea,” Ell said.

“It also means that since Korea is no longer a competitive destination for homogenous manufacturing it needs to continue moving up the value chain and lift innovation so it doesn't get stuck in a rut.”

Why moving abroad?

Experts cited three key reasons behind Korean firms expanding direct investment overseas _ logistics, labor costs and protectionism.

“First, they want to be close to the market especially for heavy items such as cars. Hyundai has a number of overseas plants including in the U.S.,” said Sohn Sung-won, professor of economics at California State University-Channel Islands.

“Second, Korean labor costs are very high, persuading businesses to produce at less expensive locations. Third, the desire to get over both tariff and non-tariff barriers is also an important reason. The ongoing trade war is likely to accelerate the trend.”

This is in stark contrast to the U.S. and Japan that both have seen rises in manufacturing jobs thanks to the so-called reshoring initiatives, the act of reintroducing domestic manufacturing to a country through various incentives.

According to the latest U.S. Reshoring Trend Report, FDI and reshoring initiatives combined to create 171,000 jobs in manufacturing in 2017 on the back of President Trump's pledge of corporate tax and regulatory cuts.

The Trump administration lowered the maximum corporate tax rate to 21 percent from 35 percent, while offering subsidies covering 20 percent of factory relocation costs.

Japan's Abe administration also took similar actions. It has cut cooperate taxes to 29.72 percent from 31.1 percent while making labor markets more flexible.

In contrast, the Moon Jae-in administration has introduced a series of anti-business, pro-labor policies by increasing corporate taxes, hiking minimum wages and reducing maximum weekly work hours.

Following a marathon meeting on Saturday, the country decided to raise the minimum wage for 2019 to 8,350 won ($7.37) per hour, up 10.9 percent from this year. The minimum wage for 2018 jumped by 16.4 percent to 7,530 won.

Minimum wage shock

“It's likely that higher minimum wages, alongside heightened global trade tensions that have resulted in tariffs on some Korean goods and the threat of further tariffs, have accelerated that already entrenched trend,” Ell said.

Analysts urge the government to come up with measures inducing local manufacturers to increase domestic investment by offering incentives and creating a business-friendly environment through deregulation.

“The government can offer a variety of incentives to encourage firms to keep operations at home including tax incentives and subsidies that would help absorb the hit from generally higher operating costs in Korea,” Ell said.

At the same time, it is urgent that Korea retool its manufacturing-dependent economy to double up efforts to bolster the service industry.

The ongoing trend could have the effect of pushing the Korean economy to become more dependent on services, but there needs to be a focus on nurturing high value-added services.

“Korea's services sector has lagged behind its manufacturing sector. To ensure Korean firms remain competitive globally, Korea needs to focus on improving the services sector to complement its manufacturing sector,” he said.

“In the long run, this will have a greater impact on the health of manufacturing in Korea than short-term policies designed to keep manufacturers in South Korea.”

However, some analysts argue it would be a mistake for President Moon Jae-in to act to prevent firms from opening factories overseas as such moves are natural to stay profitable.

“With or without minimum wages, Korean production costs are high relative to emerging markets in Asia,” said Rob Carnell, Asia-Pacific chief economist at ING Bank.

“This is not necessarily an export of Korean jobs, but potentially a necessity to maintain the profitability of Korean firms. Without this, other jobs could be lost.”