South Korea Totters on Road to Economic Gain

These should be happy times in South Korea. The country’s largest corporations, Samsung and Hyundai, have won global respect for their electronic goods and automobiles. Its scientists are making breakthroughs in stem cell research. Korean Internet games, films and pop stars have swept Asia.

But the mood in Seoul, the nation’s capital, is hardly cheery. Merchants complain about sluggish sales. Workers fret about lack of job opportunities. Many smaller businesses can’t get financing, while those who can are reluctant to hire or make new investments in Korea.

“Business is dead,” says Ko Jeong-hwa, who has been selling eyeglasses for 20 years at Namdaemun, a huge traditional market in central Seoul that is a bellwether of economic activity among working-class Koreans.

Almost a decade after the Asian financial crisis, the South Korean economy is still coping with fundamental problems that could limit its long-term growth prospects and ability to rise among the world’s budding industrial powers.

South Korea is a test case of whether a once-poor nation that has become a manufacturing exporting powerhouse can also develop a strong domestic economy and financial system. Japan, which followed a similar path of promoting its exports at the expense of its domestic economy, is still paying the price with a two-decade-long economic malaise, analysts say.

Exports certainly are the engine of the Korean economy. Booming shipments of Korean-made cars, semiconductors, electronics and industrial machinery drove the economy’s 4.6% growth last year. And although slowing in recent months, exports have been strong enough to keep gross domestic product expanding at a 3% pace this year.

By itself, that growth rate isn’t bad. Although just a third of China’s and slightly less than the U.S.’, it’s still higher than that of Japan and most countries in Europe.

But the statistics mask some fundamental challenges for South Korea’s economy, the world’s 11th largest.

One is the nation’s underdeveloped service sector, including its troubled financial industry. A more developed service sector is seen as essential to expanding Korea’s domestic economy, which is still struggling with sluggish consumer spending and tepid job creation. A recent pick-up in department-store sales offers hope that Korean consumers are beginning to recover from a credit-card binge of a few years ago that left many households deep in debt.

Another challenge is China, which has presented many nations, particularly those in Asia, with profound opportunities and risks. Although Korean-owned factories in China have helped boost exports, they also are diverting capital that could be used to further develop the domestic Korean economy, analysts say.

Further, China is increasingly a direct competitor on the export front. Just as Korea is catching up with Japan in manufacturing of higher-quality cars and electronics, China is closing in on Korea.

With the growing Chinese challenge, South Korea must become more self-sufficient and diversify its economy with such elements as a stronger financial system, growing tourism sector and promising biotech and science centers, analysts and policymakers say. All of this, they say, requires massive investments, entrepreneurship and sound financial and corporate management.

Thus far, China has been a double-edged sword for South Korea. Last year almost half of South Korea’s $8 billion of foreign direct investments went into mainland China. Most were for manufacturing operations. Samsung, Korea’s largest corporation, alone plowed $700 million into China.

The investments have allowed South Koreans to produce goods more cheaply for world markets and given them access to China’s large consumer base. Hyundai cars are top sellers in China, as are Samsung electronics and LG Electronic appliances.

But there’s been relatively little spending on new factories at home. That helps explain why manufacturing employment in South Korea has fallen in recent years.

The China factor has clearly been felt at Namdaemun, or Great South Gate, where more than 10,000 businesses operate. Down the alley in Gate 8, Kim Dal-seo sat in front of a handbag and suitcase store. Three years ago, he says, almost everything sold at his shop was made in Korea. Now, 85% comes from China.

But that hasn’t put more money into his pocket, he says. Kim points to his store’s bestseller, a gray luggage bag. That same item can be bought for $13 in Shanghai, but after duties, transportation and warehousing fees, Kim says he pays $20 for it. Kim tries to sell the bags for $25, but says customers these days haggle them down to where his profit is mere pennies.

Ko, the eyeglass retailer, still buys most of his frames from Korean manufacturers in the southern city of Daegu. But half of the eyeglass factories there have gone to China. The ones remaining produce premium, fashionable frames that Ko sells for $100 or more each.

“The Korean economy has to get better before people will spend money for these glasses,” he says, handling a pair of titanium frames. Two or three years from now, he adds, the entire Korean eyeglass manufacturing industry may wind up in China.

Even if that happens, Korean companies can capitalize on the shift by providing the Chinese with sophisticated equipment that make high-end glasses. Although South Korea isn’t blessed with natural resources, Koreans can do other things to meet China’s booming needs, such as refine oil and ship it to China, or open up South Korean ports to handle the capacity crunch at Chinese harbors, says James Rooney, president of Market Force Co., a consulting firm in Seoul.

Nor have Koreans begun to tap the potentially lucrative market for Chinese tourists, he says.

“Korea is a little ballerina with a China elephant coming up behind it,” says Rooney. “If you ignore it, it could crush you.... If you get out of the way, it’s safe but not an attractive strategy.” The best bet, he says, is to hop on its back and get a free ride.

At the moment, South Korea’s economic officials are preoccupied with trying to stimulate domestic demand. The government has cut taxes and kept interest rates low. Last month, public employees were told to stop coming in to work a half-day on Saturdays, a long-standing practice here. The move was partly aimed at creating more leisure time.

Private consumption in South Korea has been sluggish since late 2002, when five previous years of profligate credit card use came crashing down on many families.

Hwang In-seong, chief economist at Samsung Economic Research Institute, expects consumer activity to pick up in the second half of this year. People who were behind in their payments have had two years to get their finances in order, he says.

But other analysts aren’t so sure. ING estimates that South Koreans’ debt service ratio, or total debt payments as a percentage of disposal income, remains at about 25%. That’s about 10 percentage points higher than for the typical U.S. household. At any rate, consumption isn’t likely to rebound robustly without substantially stronger job growth, forecast at a tepid 1.5% rate this year.

Kim Seong-gu, chief executive of Samtoh, a popular publishing house in Seoul, learned just how desperate people are for work when he advertised for three job openings. More than 500 people applied, he says.

Every day, Kim passes a 150-foot-long line of people waiting for a free meal at a church near his office. Stores nearby that used to open at 9 a.m. now wait until noon.

“Things aren’t getting better,” he says.

One reason for the poor labor picture is that large conglomerates that dominate South Korea’s economy employ relatively few Koreans, as many of their goods are produced abroad. In fact, about 85% of the country’s 23 million workers are employed by small- and medium-sized businesses. And many of them aren’t doing much hiring.

A more diversified economy would help. South Korea has the benefit of a highly educated workforce, one of the world’s highest penetration of high-speed Internet service and, unlike Japan, a relatively youthful population. That partly explains why the arts, gaming and animation have flourished in South Korea.

But compared with other developed nations, South Korea’s service sector remains weak. Analysts say that reflects government policies favoring manufacturing, lack of experience in building those industries, and some peculiarities.

The banking sector, for one, is largely unionized in South Korea. That’s made it tough for some financial institutions to cut employment as needed. Legal barriers also stand in the way of layoffs.

South Korean securities firms, meanwhile, are still struggling as the stock market’s volatility in recent years chased away individual investors. After the nation’s 1997 financial crisis, many foreign investors bought into Korea’s financial services and other companies. Foreigners hold more than half of Samsung Electronics, the most valuable company on the Korea Stock Exchange.

But many South Koreans, including government officials, have had mixed feelings about the new foreign stakeholders, at times balking at their efforts to make management decisions or change rules of corporate governance or transparency.

Outside influence has helped bring some needed financial reforms and liberalization. But Ha-joon Chang, who teaches economics at Cambridge University, sees a downside to it as well.

Besides adding a bit of volatility to the economy, Chang says, pressure primarily from outside shareholders has prompted Korean companies to increase dividends, buy back shares to lift stock prices and invest less than they used to. As it is, he says, South Korean banks in recent years have been very conservative about lending, making less money available to businesses and more to consumers.

“I’m afraid if things are continuing in this way, I don’t see how investment will recover and revive the economy,” Chang says.

Many small business owners say what they need aren’t bank loans, but customers.

In a more upscale area next to City Hall, print-shop owner Jeon Sun-taek says sales from making business cards are way off. “We do not dream of investing when business is so down,” she says.

“For my business to improve, I think the basic economy will have to pick up,” says Im Hye-jeong, who runs a travel agency in downtown Seoul.

“People need to eat, sleep and have a roof over their heads,” she adds. “But they don’t need to travel.”

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Times researcher Jinna Park in Seoul contributed to this report.