Korea's economic cul-de-sac

By John Burton

Korea is likely to be among the most vulnerable economies in Asia if the Sino-American trade war escalates. While Korea's economic strength rests on exports, this also proves to be its biggest weakness when global trade slows.

Although the country recently signed a revised free trade agreement with the U.S., China remains its biggest overseas market and bilateral trade flows would be hurt as Beijing and Washington square off over trade.

Korea has long struggled to increase domestic demand as an engine of economic growth to balance its reliance on exports. But this has proved difficult for several reasons, including high household debt, a rigid labor market and the parlous condition of small- and medium-sized enterprises.

China is likely better able to withstand a trade war with the U.S. than Korea since it has successfully shifted away from an over-reliance on exports, whose share of annual output has fallen from a third to a fifth over the past decade as China's large domestic market continues to expand due to massive investment.

China's move up the industrial value-added chain also means that Korean manufacturing companies are facing increased competition. This is one reason why inventories in Korea are piling up, production output is slowing and manufacturing jobs are falling.

President Moon Jae-in came into office hoping to encourage increased domestic demand by raising the minimum wage through his "income-led growth" policy, giving consumers more spending power. But the move has backfired as companies have reduced hiring to save labor costs. This has exacerbated the widening income gap between the rich and poor. The government can rely on short-term measures to keep employment up by spending more to create jobs in the public sector. But this is only a quick fix.

Some conservative economists believe that the Moon administration needs to reverse course and abandon its policy of pushing for the direct hiring of outsourced workers, raising the minimum wage and shortening the workweek. They argue that a more market-oriented policy would encourage employment in the services sector, whose growth is needed to balance a decline in manufacturing jobs. They also point to how deregulation and corporate tax cuts in the U.S. and Japan, for example, have bolstered economic growth and increased employment.

These views are an anathema to the Moon administration. One reason is that such measures will likely strengthen the economic grip of the large family-owned conglomerates, or chaebol, when the government is trying to introduce new rules to curb their power and promote fair competition.

Moon faces an almost impossible dilemma when it comes to the chaebol. On the one hand, he needs their cooperation if he is to revive the economy in the short-term. On the other hand, the lack of substantial chaebol reforms will hamper the business environment and the prospects for economic growth in the long-term.

Last year the President campaigned for chaebol reform by promising to introduce tougher penalties for corporate crimes, improve corporate governance, give minority shareholders more power to nominate board members, and reduce chaebol lobbying of the government.

Many economists have argued that Korea has become dangerously reliant on the chaebol for economic growth. The top 30 big businesses account for 66 percent of Korea's exports and 71 percent of industrial investment. The chaebol have also been criticized for overinvesting in risky ventures because they have easy access to capital. These vulnerabilities could be exposed if global trade slows.

For example, semiconductors are the main profit center for Samsung Electronics, but a Sino-American trade war would likely reduce the company's chip exports to China, its biggest overseas market.

The Moon administration proposed legislation in August that would grant powers to the Ministry of Justice to police the chaebol for antitrust practices. Other measures would require chaebol holding companies to increase their shareholdings in listed and unlisted subsidiaries, while placing new limits on trading among the affiliated units of the same chaebol group.

Moon's "income-led" economic policy has made it more difficult to pass chaebol reform laws since it has undercut his popularity as unemployment rises. The ruling Democratic Party of Korea already lacks a parliamentary majority and opposition parties are positioning themselves to take advantage of Moon's declining support among voters.

If Moon's chaebol reform program fails, it will mean that Korea will have problems in creating domestic demand in the future. The dominance of the chaebol has made it difficult for small businesses to grow and pay better wages to skilled workers. Since the chaebol tend to favor their own affiliated units for products and services, this starves smaller outside firms of business opportunities.

The resulting loss of competitiveness bodes ill for the prospects of a vibrant domestic-demand economy that would rescue Korea from its export trap.

John Burton (johnburtonft@yahoo.com), a former Korea correspondent for the Financial Times, is now a Washington, D.C.-based journalist and consultant.