May 29, 2011 7:37 pm

South Korea: An economy divided

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As chaebol recover, pressure is on policymakers
Korea Seoul

Mean streets: South Korean households are feeling the pain as they struggle to service debt. With less money to spend, consumers are cutting back

South Korean police identified the 35-year-old only as Mr Bang. He killed himself in the southern province of Jeolla on March 10 by locking himself in his car and lighting a brazier of charcoal briquettes. The note he left was stark: “I am tormented by my debts.” His final words, an expression of personal suffering, reflect the troubles of the nation.

Mr Bang’s case is not unusual. South Korea has one of the world’s highest suicide rates, worsening rapidly as the gulf widens between rich and poor in a faltering and uneven domestic economy. Suicide has doubled in the past decade to account for 31 in every 100,000 deaths.

Such tales jar with the widespread view of South Korea as an economic success story. Internationally, it is praised in the same breath as Germany for the speed with which massive export-based conglomerates – called chaebol – have powered recovery from the crisis of 2008. Companies such as Samsung Electronics and Hyundai Motor posted record profits last year. Exports rose 29 per cent to $467bn, contributing to a 6.2 per cent rise in gross domestic product.

Many of South Korea’s chaebol gained market share in the most recent economic downturn, faring much better than they did after the Asian crisis of 1997 when many had to be broken up. Boosted by a weak won and a strong yen, they have hammered Japanese competitors in manufacturing.

However, national economic success disguises financial distress among small businesses and indebted householders that could undermine the recovery. Household debt has swollen to 146 per cent of income, topping the US’s 138 per cent at the outset of the subprime crisis.

“The economy seems to be in good shape if we look at the headline figures but most ordinary people don’t feel it. The high suicide rates are partly due to the weak social safety net, unstable employment and high youth unemployment,” says Kim Sung-il from the Korea Association for Suicide Prevention.

Duncan Wooldridge, an economist at UBS, says this polarisation is tangible in macroeconomic data that show “very strong exports versus weak domestic demand fundamentals”. Hyundai Motor’s 2010 sales neatly show the two-speed nature of the economy. While they leapt 18 per cent overseas, they slid 6 per cent at home.

South Korea has attracted strong foreign capital flows from investors betting on the broad strength of the economy. But these could tail off if domestic weaknesses bite harder. Indeed, as China becomes a more powerful competitor in manufactured goods, South Korea’s need to reduce its dependence on a dozen chaebol and strengthen the rest of the economy is a pressing policy challenge.

This schism has leapt to the top of the political agenda. President Lee Myung-bak is beseeching chaebol to share their riches with the rest of the economy, particularly small and medium-sized business, which account for 90 per cent of jobs.

“Initially the government hoped chaebol-friendly policies would trickle down to the have-nots,” says Hong Jong-haak of Kyungwon university. “When the government found this did not work, they rushed to implement policies to help small- and medium-sized businesses.”

So far, success has been slow in coming. Critics say that the chaebol are still squeezing their SME suppliers hard in order to cut costs. Shin Sang-hong of the Korea Federation of Small and Medium-sized Business says polarisation of the economy is accelerating and that it remains hard to change the mindset of the chaebol. “Many SMEs are having trouble staying afloat,” he says.

Professor Chang Sea-jin at the National University of Singapore says politicians are also waking up to the dangers of domestic fragility as the chaebol produce more abroad rather than creating quality employment opportunities at home. “There is a crisis building up,” he says. “The domestic side has to be developed with more disposable income. People cannot consume. Internal pressure is cooking.”

While households in Britain and the US were busy reducing debts, South Korea’s rose 9 per cent last year. Seoul has played down the risk of such credit, saying strict rules on mortgages, which account for 45 per cent of the debt, make it safer than the US and the UK. But officials have become increasingly nervous. Last month, the central bank warned that houshold debt was threatening to undermine financial stability; a leading policymaker privately called it a “time bomb”. Regulators say controlling consumer debt is their main task for 2011 and promise an action plan in June.

South Korea suffered a credit-card crisis in 2003 and had to bail out lenders. Erik Lueth of Royal Bank of Scotland says the financial system is not in so much peril today but warns that the danger to consumption and growth could be just as great.

The weight of consumer debt means the central bank is wary about lifting interest rates from 3 per cent to combat inflation, which hit 4.2 per cent in April. Mr Lueth argues the Bank of Korea has to act before the situation becomes more grave. Defaults remain less than 1 per cent. “Household debt is no obstacle for interest rate hikes and, on the contrary, should be a key motivation. At current interest rate levels, households are likely to leverage up further,” he says.

Servicing debt is bleeding household budgets. Disposable income is falling sharply and savings have plunged to less than 3 per cent of income from about 25 per cent in the early 1990s.

. . .

A lunchtime walk through central Seoul reveals how people are shaving expenditure. Businesspeople increasingly head for convenience stores to slurp down a Won1,000 (90 cents) pot of noodles rather than buy a Won6,000 restaurant lunch.

Convenience stores report noodle sales are up 30 per cent this year. Sales of packed lunches of kimbap – Korea’s version of sushi – rose 100 per cent last year.

Other trends include increased metro usage, commuters sharing cars and surging demand for bedsits. The income gap is widening sharply, with the top 10 per cent of society earning 4.73 times more than the bottom 10 per cent, up from a multiple of 3.64 times in 1995. In Denmark, Sweden and Switzerland, the multiple is close to three times.

In response to this growing polarisation, President Lee says his priority is “shared growth” to narrow the gap between chaebol and SMEs. In addition to pressuring SMEs on cost, chaebol are notorious for buying out promising ones, if only to strip out talent and snuff out competition.

But the plans have sparked scorn from both chaebol and economists. This year, Korea’s most important businessman, Lee Kun-hee, the Delphic chairman of Samsung, levelled a rare swipe at the government, attacking its latest concept: profit-sharing. Mr Lee suggested this reeked of socialism. “I have studied economics and grew up in a family of entrepreneurs but I have never heard of the concept of profit-sharing,” he said.

Even the SMEs themselves are unconvinced. Yoo Kwang-soo of Korea’s Federation for Small and Medium-sized Business also says profit-sharing misses the point. “The chaebols’ high profitability is possible thanks to cheap components from their SME contractors. If they pay proper prices to their SME suppliers, they don’t have to share excess profit with SMEs. In order to address such imbalances, big companies should pay reasonable prices for their components, and pay on time.”

SME managers are sceptical the government will make the chaebol more accountable. The president has shown his willingness to put the chaebol above the law by pardoning chairmen – including Samsung’s Mr Lee – convicted of serious financial crimes.

But economists stress the government appears to be bolstering its tradition of protecting SMEs politically rather than increasing efficiency by allowing bad SMEs to fail. Its proposals do not include painful reforms for the heavily protected sector. Foreign bankers in Seoul regularly complain of intense political pressure to extend loans to failing SMEs.

Kim Ki-hwan, chairman of the Seoul Financial Forum, a think-tank, argues the government is mistakenly trying to build up SMEs with preferential credit in the same way in which it forged the chaebol in the 1960s and 1970s. The weakness of the sector means they still source their highest quality goods from superior Japanese competitors. “Every bureaucrat has his own scheme for protecting SMEs. Each one wants to be Santa Claus,” he says. “The government is going about this in the wrong way by trying to provide preferential loans.”


The government is also failing to reduce the burden of education spending. South Korea spends more per head on education than any other country and couples burn through about 30 per cent of income on private night schools dedicated to getting children through state exams. Youth unemployment is soaring as 407 universities churn out an overabundance of unemployable graduates.

President Lee has vowed to plug this financial drain by extending vocational education. He proposes a system of schools based on the German guild system, which he hopes will steer parents away from an expensive obsession with getting their children into university. So far, however, he has only created 21.

. . .

South Korea has proved adept at bouncing back after crises, like those in 1997 and 2003, but then shied away from any major structural reforms that would build up the SME sector to challenge Japanese middle-order, high-precision engineering companies. It means the country is highly prone to cyclical shocks with little depth in domestic consumption to fall back on.

Seoul’s most controversial sign of favouring the chaebol over smaller, domestically focused businesses is its tendency to intervene in the currency market. While international critics, particularly Japanese rivals, say the country is keeping the won low for the chaebol, Seoul insists it simply smoothes volatility.

“Resisting currency appreciation will further favour exporters at the expense of domestic oriented firms and household income. This policy is unsustainable now that inflation and oil prices are moving higher,” says Mr Wooldridge at UBS. “Policy cannot favour exporters for ever.”

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