ING Business Opportunity Report Economics Department South Korea: new growth model emerging? Summary conclusions The growth outlook for Korea in the short to medium term is positive. ING forecasts economic growth of 3.5% per annum for 2014, 2015 and 2016. Consumption and investment are picking up. After a period of slow increase, export growth is forecasted to show a moderate acceleration in the coming years. In the medium term the Korean economy faces significant challenges. From 2017 ageing will cause a decline in the potential labor force. This means that economic growth will depend mainly on labour productivity. Structural weaknesses has put a break on growth of labor productivity because: the development of the service sector, with its low productivity, is lagging that of industry more than in other developed economies. Korea attracts little foreign direct investment (FDI) and so misses out on the productivity impulses often generated by these investments. although Korea invests relatively much in R&D and patent filings are high, the return on these investments are relatively low, reflecting mediocre productivity growth. small- and medium-sized companies are financially vulnerable and have low productivity. as the number seven on the World Bank ranking Korea scores well on ease of doing business. At the same time Korea is the advanced country with most impediments for trade and foreign investments, according to the OECD. regulations of Korean product markets are stringent and the dominant conglomerates lack sufficient competition. These characteristics of the Korean economy hamper the desired turnaround of an industrial export led economy towards one in which smaller and creative companies foster productivity. The Korean government is aware of these problems and last February announced a three year innovation plan to address these issues. Swift and decisive implementation of the plan is crucial for achieving the desired turnaround. Korea is an open economy and is among the top five exporters in the world. Korea has a surplus in trade of goods and services of $45bn (3.7% of GDP). Korea s exports are dominated by machinery, transport equipment (cars), other manufactured goods and chemicals. Korea s exports are expected to grow at 5-6% per year over 2014-2019. Chemical products and industrial machinery are expected to show the fastest export growth during this five year period. Korean imports are dominated by mineral fuels and machinery & transport equipment (office machines). Imports of manufactured goods are significant. Korea s total imports are expected to grow by 6-7% per year for the period up until 2019, with machinery and transport equipment overtaking fuels as the number one import category. With the Netherlands, Korea runs a surplus of $1.3bn (2013). Most exports from Korea to the Netherlands consist of mineral fuels, machinery & transport equipment (cars) and manufactured goods and chemicals. Korean imports from the Netherlands are dominated by machinery and transport equipment. The trade surplus for Korea with the Netherlands is expected to turn into a small deficit of $0.9m in 2018, partly because the Korean economy is growing faster than the Dutch. That will lead to faster import growth in Korea.
A new growth model South Korea was among the fastest growing OECDeconomies during the first decade of this century (see table 1). After the financial crisis in 2007-09, initially the Korean economy stood out with a relatively strong recovery. Economic growth slowed significantly from the second half of 2010. Since mid 2013 GDP growth rates have accelerated again and currently amount to 3.5%. Notwithstanding that high household debt poses a risk for the stability of the economy, ING expects GDP growth at 3.5% (YoY) in 2014, 2015 and 2016. If the growth recovery stalls then the Korean authorities seem to have some scope to support growth with monetary or fiscal stimuli. The budget deficit, including the balance of the social security funds, is around zero and the inflation rate is 1.4%, below the 2.5-3.5% Korean Central Bank inflation target, although core inflation is higher at 2.4%. Structural developments in Korea inhibit a return to the high growth rates of past decades (6-9% per year). In the four decades up to 2000, Korea lifted its income per capita from 10% to 60% of the US level. An important driver behind this catch up has been the extra input of labour. The contribution from increased input of labour to economic growth decreased from nearly 40% in the 1970s to almost 20% during the first decade of this century. With population growth is becoming negligible, the working age population will start to shrink in 2017 (see table 1). Table 1 Contributions to economic growth in Korea 1970-80 80-90 90-00 00-10 National Income (%) 7.8 9.3 5.8 4.6 Inputs 5.0 5.1 3.0 1.7 Labour 3.1 3.4 1.8 1.0 Capital 1.9 1.7 1.1 0.8 Productivity growth 2.8 4.2 2.8 2.9 Source: OECD With ageing, the Korean Development Institute expects the potential for economic growth to decline from the current 4% pa to 2.75% in the 2030s. If the Korean economy is to surprise on the upside then productivity growth will have to accelerate. Easy productivity gains have already been reaped during Korea s rapid catch up process of recent decades. According to the OECD, a productivity boost requires a new growth model. Korea needs to switch from an export-led growth Figure 1 Overall product market regulation*, 2008, 2013 * A higher score means more regulated product markets Source: OECD model to a model that focuses more on innovations in a creative economy. This requires more space for the service sector and small and medium sized enterprises (SMEs). The economy needs to foster more competition by lowering barriers for entrepreneurship and less product market regulation. Korea does not score well in these areas. This was the case five years ago and still is (see figure 1). The Korean government acknowledges most of the above problems and last February launched a three year innovation plan. The realisation of the intended switch to a different growth model will partly depend on the success of implementation of his plan. Making Korea more attractive for investors Because of its geographical position Korea plays a role as a gateway to China. In sectors like the food industry Korea is triying to expand this role. Although re-exports to China are rising and there is potential to extend this springboardfunction to the second largest economy in the world, this requires investments. With seventh place in the World bank Ease of Doing Business ranking, Korea s overall score for attracting foreign investors is good. The ranking is significantly better than the Dutch ranking (28 th ) and is the best in the Asian region except for Singapore. Half of the ten indicators that measure the ease of doing business, have improved since 2005. For some aspects of doing business Korea doesn t score very South Korea: new growth model emerging? 2
Figure 2 Barriers to trade and investment*, 2008, 2013 Figure 3 Korean imports by product group, 2013 * The higher the score, the more regulated the product markets are Source: OECD well. According to the World Bank, registering a property in Korea is more costly than in many other Asian economies, with a ranking of 75 (Netherlands: 47). Investor protection is at best mediocre (but better than in the Netherlands). Starting a business was never cheap in Korea and has, in comparison with other countries, became even more costly recently (a drop from 23 rd to 34 th place in the rankings, compared to 14th for the Netherlands). Korea s good position in the World Bank ranking doesn t necessarily mean that foreign companies can be successful in the country. The OECD points out that Korea is the country within the OECD that has put into place most obstacles for trade and foreign investment (figure 2). Unctad figures show that Korea has attracted relatively low foreign direct investment; the total stock of inward foreign direct investment adds up to $167bn in 2013, only 14% of GDP. In the Netherlands this number is 84% and the average in the industrialised world is 40%. Recent developments in Korean labour costs have not made Korea more attractive for offshoring. While Dutch labour costs have been on hold since the start of the crisis, in Korea labour costs have risen sharply. This might have contributed to Korean companies increasingly investing abroad. Although outgoing foreign direct investment is not high (17% of GDP in 2013), it is four times as high as ten years ago. Incoming investments have not experienced a similar rise, being roughly at the same level as ten years ago, Unctad figures show. While rising wage costs diminish the attraction of Korea as a production location, they also enhance the purchasing power of Korean households and so make Korea a more attractive market in which to sell Dutch products and services. Anecdotal evidence points to a growing market for luxury goods. This creates, as the experience of Heineken shows, increasing possibilities for exporting premium goods in product groups like food and beverages. Another sector that has been booming, thanks to the growth of purchasing power of Korean households, is the gaming industry, one in which the Netherlands traditionally holds a strong position. Trade flows: Korean imports Measured by trade flows, Korea s economy is quite open. Import and export ratios are above the OECD average. According to Unctad, Korea had a surplus in trade of goods in 2013 of $45bn (3.7% of GDP). Korean imports are dominated by mineral fuels and machinery & transport equipment. Within the latest category, office machines, telecommunication equipment and electrical machinery are important. Also, imports of manufactured goods are significant (figure 3). South Korea: new growth model emerging? 3
Figure 4 Origins of Korean imports, 2000 and 2013 Figure 5 Korean imports from the Netherlands, 2013 In the years up until 2019 machinery & transport equipment should overtake fuels as the most important import category, according to forecasts by Oxford Economics. Demand for office machines, telecommunication equipment, electrical machinery and industrial machinery will continue to grow especially quickly. Aside from fuels, the share of ores & metals and basic food in Korean imports will also diminish in the years to come. Japan used to be Korea s most important foreign supplier of intermediate and final goods. Today China is by far the most important supplier. Japan is in second place, followed by the US and the fuel suppliers of the middle east. Australia is also a significant exporter to Korea (figure 4). Imports from the Netherlands totalled $4.2bn in 2013, less than 1% of total Korean imports, but four times as much as in 2000. From the Netherlands Korea mainly imports specialized industrial machinery (part of machinery & transport equipment). The import from the Netherlands of these machines makes up almost half of all Korean imports from the Netherlands. This is also the product category that, together with office machines, telecommunication equipment, and electrical machinery, has shown the steepest increase in exports to Korea since 2000. Dutch chemicals are the second biggest import category, but it s share has diminished from 19% in 2000 to 13% in 2013. Korean exports The recent development of Korean exports shows a similar pattern as GDP. After the 2010 recovery following the big export drop of 2009, exports showed double digit growth in 2011. Since then exports have underperformed, with average annual growth of 1.3%. Korean exports are dominated by machinery & transport equipment (especially road vehicles). Manufactured goods and chemicals also make up a significant part of Korean exports. During the last 5 years the composition of Korean exports has changed little (figure 6). China is by far Korea s biggest export destination, with a 26% share of Korean exports. This share has more than doubled since 2000. The US has dropped on this ranking Figure 6 Shares of product groups in Korean exports South Korea: new growth model emerging? 4
Figure 7 Destination of Korean exports 2013 (2000) Figure 8 Shares of product groups in the export to the Netherlands 2013 and 2000 since the turn of the century. It fell from first to third place with a share cut in half to 11%. Japan comes in second and has also experienced a drop of 50% in its share of Korean exports. Korean exports to the Netherlands amount to $5.5bn, less than 1% of total exports, a 12 th spot. (see figure 7). Within Korean exports to the Netherlands, mineral fuel dominates. Overall exports are expected to show growth of around 5% to 6% per year for the period 2014-2019. According to Oxford Economics forecasts. the fastest growing export product groups until 2019 will be chemicals and industrial machinery. Telecommunication equipment, office machines and electrical machinery are also expected to grow fast. Road vehicles and transport equipment are currently the largest export product groups. They are part of machinery & transport equipment and are expected to show export growth in line with the average over the next five years. The reason behind the turnaround in the bilateral trade balance between Korea and the Netherlands can partly be explained by the fact that Korean imports in general will grow more than Dutch imports. Korean economic growth will be higher than Dutch growth in the coming years, according to ING forecasts. Higher growth is accompanied by higher domestic spending. This causes growth in import demand to be higher in Korea than in the Netherlands. Korean imports are expected to grow by 6-7% per year for the period to 2019, higher than expected growth in exports (5-6%). Korea runs a limited trade surplus with the Netherlands of $1.3bn (2013). This surplus will, according to Oxford Economics, turn into a small deficit of nearly $900m by 2018. A widening Korea trade deficit with the Netherlands in the working machinery product group is mainly responsible for this turnaround. Other product categories are expected to show a more favourable balance for the Netherlands, including transport vehicles and equipment, organic chemical products, non-primary plastics, and telecom sound equipment. South Korea: new growth model emerging? 5
For more information please contact: Raoul Leering Head International Trade Research +31 6 13 30 39 44 raoul.leering@ing.nl Tim Condon Chief Economist Asia +65 62 32 60 20 Disclaimer This publication has been prepared by ING (being the commercial banking business of ING Bank N.V. and certain subsidiary companies) solely for information purposes. It is not investment advice or an offer or solicitation to purchase or sell any financial instrument. Reasonable care has been taken to ensure that this publication is not untrue or misleading when published, but ING does not represent that it is accurate or complete. The information contained herein is subject to change without notice. ING does not accept any liability for any direct, indirect or consequential loss arising from any use of this publication. This publication is not intended as advice as to the appropriateness, or not, of taking any particular action. The distribution of this publication may be restricted by law or regulation in different jurisdictions and persons into whose possession this publication comes should inform themselves about, and observe, such restrictions. Copyright and database rights protection exists in this publication. All rights are reserved. ING Bank N.V. is incorporated with limited liability in the Netherlands and is authorised by the Dutch Central Bank. United States: Any person wishing to discuss this report or effect transactions in any security discussed herein should contact ING Financial Markets LLC, which is a member of the NYSE, FINRA and SIPC and part of ING, and which has accepted responsibility for the distribution of this report in the United States under applicable requirements. The final text was completed on 23 October 2014.