Chitchat South Korea is Sinking - Sounds Familiar to Sinkies?

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KOREA’S POLITICAL SCANDAL THREATENS A DESCENT INTO JAPANESE-STYLE STAGNATION
BY TOM HOLLAND
5 DEC 2016

It’s been a rough few months for South Korea. First the country’s leading shipping line went bust. Next the new flagship product from its biggest corporation turned to be an expensive and dangerous dud. Then President Park Geun-hye got embroiled in a political scandal so severe that her unseemly departure from the head of state’s Blue House now looks to be only a matter of time.

Exactly how much time could prove crucial. As long as Park remains in office, Korea will remain locked in a state of policy paralysis. And until a successor with a solid political mandate is installed in her stead, Seoul will have no opportunity to tackle a suite of deepening economic problems which, if left unaddressed, threaten to see Korea follow the same path into deflationary stagnation that Japan trod more than 20 years ago.

The signs are not encouraging. Last week Park did offer to resign, but only once parliament had agreed a plan for “the stable transfer of power”. Her offer was promptly rejected by opposition politicians, who saw it, with considerable justification, as a desperate attempt to delay her departure. Instead they are intent on impeaching the president following revelations that she has long been in thrall to her friend and confidante Choi Soon-sil, a private citizen who not only appears to have had an undue influence over Park’s policymaking, but who also shamelessly exploited her connections to the president to extort vast sums of money from some of Korea’s leading companies.

The trouble is that impeachment will take time, possibly as much as six months between an initial parliamentary vote and the final verdict from Korea’s constitutional court. Worse, Park’s successor will inherit an office damaged by the long and divisive impeachment process, and will inevitably have to devote the main part of his or her energies to healing political wounds and restoring the authority of the presidency. That means the new president will not be able to focus on pushing through the economic reforms that Korea so badly nee

From a distance, Korea’s economy looks like a roaring success, despite occasional hiccoughs like the August bankruptcy of Hanjin Shipping, or the October withdrawal by Samsung Electronics of its new Galaxy Note 7 smartphone after a series of battery fires. Seen up close, however, it is a different story. For years Korea has been a manufacturing and export powerhouse, thanks in large part to an industrial strategy that prioritised the external sector. Yet in the last two years Korea’s export engine has stalled in the face of weak global demand and heightened competition; since the start of 2015, monthly exports have registered year-on-year growth just twice.

In the past, won depreciation might have helped. But with the Japanese yen down by almost a third against the Korean currency over the last five years, these days exchange rates are a headwind rather than a tailwind for Korean exporters. As a result, policymakers will have to look to the domestic economy to power future growth, and specifically to the country’s service sector.

The good news here is that there is plenty of room for improvement. Korea’s service sector is woefully inefficient. According to the Paris-based Organisation for Economic Cooperation and Development, productivity in Korea’s service sector is just 40 per cent of its manufacturing sector productivity. The comparable statistic for the United States is 80 per cent.

However, the obstacles to raising productivity are formidable. Korea’s labour market is inflexible even compared with Japan’s before its “Abenomics” reforms of recent years, with the participation of women in the workforce even lower. And the powerful chaebol (family owned) corporate groups that control much of the domestic economy have exerted all their considerable power to resist reforms that would enhance competition.

In the absence of export growth or productivity gains, much of Korea’s recent growth has been propelled by increasing debt. Household debt is close to 90 per cent of gross domestic product, the highest in emerging Asia. Factor in corporate debt and the debts run up by the government and state-linked bodies, and overall non-financial sector debt now exceeds 200 per cent of GDP.

That’s not an immediate problem. With most of the debt financed domestically, there is little chance of a 1997-style crisis. But with banks overly willing to roll over credit to troubled borrowers, Korea hosts a veritable legion of potential Hanjins, zombies kept going by financial life support whose survival threatens to destroy the country’s future growth prospects.

If this sounds familiar, it is because Korea today bears more than a passing similarity to Japan in the 1990s. If left unaddressed, its problems promise a decade or more of expanding debt, diminished demand, deepening deflation and dismal growth. To tackle them, however, requires the sort of tough structural reforms that only a decisive, resolute and focused leadership can institute. Unfortunately, because of Park’s political scandal, there is little chance Korea will get that any time soon. ■


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