Participants watch South Korean President Park Geun-hye delivering a speech on small screens fitted in their seats during a ceremony marking the 69th anniversary of liberation from Japan's 1910-45 colonial rule, on Liberation Day in Seoul August 15, 2014. REUTERS/Kim Hong-Ji (SOUTH KOREA - Tags: POLITICS ANNIVERSARY CONFLICT) - RTR42HRB
President Park Geun-hye has made the “creative economy” the central point of her policy agenda © Reuters

South Korea is good at overcoming short-term crises but the manufacturing-driven economy is now facing longer-term challenges to sustain growth amid increasing competition from neighbouring China.

Big export-based conglomerates called chaebol have led the country’s rapid industrialisation over the past half a century on the back of state financial support and regulatory protection to make the country the world’s 10th largest trading nation by volume.

South Korea has become a global leader in sectors including shipbuilding, flat screens, mobile phones and memory chips. There are growing questions, however, over whether a handful of big manufacturers such as Samsung and Hyundai can continue to drive growth, especially as China is catching up fast in many industrial sectors.

“[South] Korea’s manufactured exports are losing competitiveness due to the narrowing technology gap with China, whose manufacturing industry is gradually shifting to higher-value-added goods,” says Lee Jong-wha, economics professor at Korea University.

China has become a powerful competitor to South Korea’s manufactured exports such as steel, ships, petrochemicals and electronics, although it is still way behind South Korea in some high-tech areas such as memory chips and automobiles.

“[South] Korean exporters, who have focused on catching up with Japanese and US rivals, have no strategy to fend off competition from China,” says Lee Geun, economics professor at Seoul National University.

The country’s dominant business groups have come under particular pressure this year. Samsung Electronics has posted declining earnings for four consecutive quarters. Its operating profit plunged 60 per cent to a three-year low in the third quarter as it concedes market share to low-cost Chinese rivals such as Huawei and Xiaomi.

Hyundai Motor’s net profit dropped nearly 30 per cent in the third quarter as it is losing ground to Japanese rivals in the US with the weaker yen enabling Toyota, Nissan and Honda to offer big sales incentives to consumers. Hyundai also outraged investors by offering $10bn for a trophy headquarters site, raising questions about its corporate governance and capital management.

Increased doubts over the chaebol-led economic model have sparked calls to reduce the country’s dependence on such companies and strengthen the rest of the economy, especially small and medium-sized business and the underdeveloped service sector.

“The growth model driven by a handful of big exporters has hit a limit,” says Suh Dong-hyuk, researcher at the Korea Institute for Industrial Economics and Trade. “We should promote innovation in start-ups and SMEs and develop service industries for more balanced and sustainable growth.”

Under the slogan of promoting a “creative economy,” President Park Geun-hye is trying to foster an environment where venture firms can flourish by expanding financial support for innovative start-ups. But she has not made much headway in implementing her election campaign promise of curbing the chaebol’s power and propping up SMEs.

Small businesses still struggle to grow in the shadow of sprawling chaebol companies, which aggressively push down the prices of their suppliers or push independent rivals out of business with their economies of scale.

“Despite political efforts, the business environment where big businesses make profits at the expense of their small suppliers has not changed much,” says Mr Suh.

Experts say South Korea needs quickly to develop internationally competitive service industries such as medical tourism and IT services, if it is not to stall. They urge the government to increase the service sector’s productivity through deregulation while businesses should step up efforts to seek new growth drivers.

“The era for unconditional capacity build-up for capital-intensive industries is gone now,” says Michael Na, strategist at Nomura. “We should make money by selling competitive platforms and services.”

Overhauling the economic framework is not easy. Although South Korea boasts global manufacturers with vast international operations, regional expansion has been a painful process for its service providers.

A decade into their efforts to go global, the country’s banks still struggle to build a presence in other countries, while retailers such as Lotte and E-mart have suffered big losses while expanding into China and other parts of Asia.

“Selling services is harder because you should understand others’ culture,” says Mr Na. “But many of our business leaders unfortunately lack such global sense and knowhow needed for successful overseas expansion.”

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