South Korea: Drifting Economy, Boiling Society

Korean society appears to be focusing on democratization and empowering people, demystifying government power, as well as decreasing the scope and social tolerance of corruption. Because of this, economic liberalization may take a backseat. Indeed, Korean society appears to be focusing on reducing the income inequality that economic liberalization may exacerbate.

Korea’s economic establishment is deeply bearish about the present state of affairs, fearing that the lack of direction will depress the economy in the short term and may damage Korea’s longer-term economic competitiveness. The economic establishment was either associated with or at least prospered under the former military dictatorship that the present political and social leaders risked their lives opposing. The level of dialogue between the two is minimal.

Foreign institutional investors who own majority stakes in major listed companies harbor the hope that Korean investors will turn bullish and elevate the market that foreign investors deem cheap. This hope is unlikely to be realized, and Korea is on a course that favors bond investors, in my view.

Recently, I visited Korea for two days mainly to discuss the China economic situation with Korean businesses and domestic institutional investors. Korea’s exports to China and Hong Kong have increased to 28% of the total now from 17% in 2000. China and Hong Kong have accounted for about half of Korea’s export growth since 2000 when NASDAQ peaked. Korea’s corporates have integrated the Korean economy with China’s via massive capex in the later. It is understandable that Korean corporates care about China’s cyclical outlook. Indeed, China’s economic cycle is likely to drive Korea’s for a long time to come.

I also took advantage of the opportunity to assess Korea’s economic situation. I was shocked by the extreme bearish sentiment in the business community as well as among domestic institutional investors. The recent economic data, while not bullish, are improving. One would not suspect such bearish sentiment based on such data. However, I believe this explains why 5-year treasuries are trading at 4.5% even though June CPI reached 3.6%. Korean investors seem to believe that the nominal GDP growth rate will be around 5% in the future.

The bearish sentiment in Korea that I felt was worse than what I sensed in Taiwan in March, and I believe the similarity is a loss of direction among the economic elite. The background is of course the migration of manufacturing to China and the ‘life-after-manufacturing’ that is yet to be born. Japan has been going through the same angst for years. It seems that even though the factories are gone, the people are still waiting outside the gates.

However, as the economy drifts, Korean society looks to be undergoing a revolution. The people who risked their lives protesting against the military dictatorship are now in charge, voted in by a generation who refused to put a full stomach above social values. The overarching objective appears to be to democratize the society: demystify bureaucratic power, empower people and minimize social tolerance for corruption.

This generational change is the force that drives Korea’s social development. The generation that worked their way up under the military dictatorship put economic prosperity above everything else. They grew up hungry. The generation that grew up during the military dictatorship didn’t experience the same economic hardships and desire a better society beyond money economics. In my view, there are striking parallels between Korea, Taiwan and Hong Kong in what people desire. Singapore is the only exception to this among the Asian Tiger Economies that boomed in the 1980s and 1990s.

Korea’s establishment appears disconnected and mostly ambivalent about social change. Obviously, most of the established businesses or social organizations benefited during the military dictatorship. They do not benefit from the current social changes, which are inherently about more income equality. Indeed, the establishment class has little connection with the people who are running the country or driving the socio-political changes.

In most mature market economies, businesses lobby political leaders and fund their campaigns to balance the power of the masses. This normal give-and-take process keeps the free market system alive. However, because of Korea’s history, such a give-and-take process is associated with the military dictatorship and, hence, is discredited. The current generation of leaders appears to be determined to stamp out corruption.

The property sector is still a pillar of the economy, even though the price of luxury property has corrected from the giddy levels seen in 2002-03. The main driver of this has been negative real interest rates ? the central bank discount rate is at 3.5% but inflation is already higher than that. It is therefore unsurprising that the property sector is buoyant.

As the Fed has started raising interest rates, Korea is facing the dilemma that confronts other Asian countries: while the economy is decelerating, interest rates are too low given the current inflation. If Korea follows the Fed, the property sector would cool, thus deflating the only strong sector in the economy.

I believe that the Bank of Korea should appreciate the damage that negative real interest rates can do to the economy in the end. Negative real interest rates exaggerate property demand in the short term, i.e., borrowing growth from the future. It is still too early to say what a neutral interest rate in Korea is, because the low inflation environment has been around for only five years.

I believe that Korea’s trend growth rate is between 3-3.5% and the inflation rate is between 2-3%. The long-term nominal GDP growth rate should be 5-6.5%. The neutral central bank rate is probably 4-5%. Korea’s interest rate, therefore, is not too far below the neutral level. Raising interest rates does not yet appear to be urgent.

Financial markets usually jump to criticize when a country does not try to improve the short-term growth prospects. Stock markets, for example, fluctuate strongly in line with economic cycles. However, the foundation for long-term economic growth lies in social values and political structure. I believe that what is occurring in Korea is not necessarily bad for the economy in the long term.

Weak consumption is a problem that confronts many Asian economies and I believe that only major socio-political evolution can change this. When people are not in charge of their destiny, they are likely to save more. That was okay when Asian economies needed rapid capital formation. However, as several Asian economies must move beyond industrialization, this insecurity would appear to be holding them back. Major social changes may be necessary for the transition.

In my view, the disconcerting aspect of Korea’s social revolution is its strong socialist bent. There is a sense that much of wealth that belongs to the elite was accumulated unfairly. It is hard for me to argue either way. But I do not want Korea to increase economic rigidities in the hope that they may help alleviate income inequality. Otherwise, Korea’s economy may become similar to Japan or Europe, well off but stagnant.

Thanks.

The Jenkins thing down in Jakarta is VERY interesting right now. Japanese TV have hunted down and filmed very nervous DPRK officials down there who are shadowing Jenkins and look like keystone cops (they are losing control over him it seems). It's almost humorous.

Gongfei fangpi zhe Xie.

The lesson is freedom is bad for business and the economy (ie be more like China).

Lesson 2. N. Korea will be the place to invest, a huge bull -- soon as Wen Jiaobao and dear leader get the details of the opening worked out.

Re #4

I am not sure you get things right. What the current S. Korean government does is not for more freedom. When leftists say democracy, it means letting loose all leftist agenda and clamping down on their opposition. Attempt to dominate media outlets, enforcing political correctness, reckless public spendings, to name a few. The situation is way different from what is going on in China. Union members in S. Korea is well-off. Most of them have their own cars. S. Korea autoworkers' hourly wage is now quite close to average of American autoworkers.

He left North Korea on Friday saying he had intentions to go back to North Korea. He also sounded a bit aloof towards his family in North Carolina (this again, while he was in Pyongyang).

But once he got to Indonesia and safely with Soga and the girls to the 14th floor of Hotel ________________ in downtown Jakarta, away from the DPRK 'shadows' down on the fifth floor, he only had his obligatory Kim il Sung badge on for about day.

He has now taken it off, and he also said he wants to go with the wife to Japan, from what I understand.

This is very intriguing indeed. Get ready, TLR, later today I will post the links to a Japanese TV video stream today where the japanese journalists ended up 'trailing' the north korean spies who were trailing Jenkins.

Personally, I don't see how the Roh government, which, lest you forget, was impeached by a duly elected parliament, is any less corrupt than it's right wing predecessors in the 1980s.

In fact, Kim Dae Jung's entire "Sunshine Policy" was the result of corrupt deals entered into by Kim's Millennium Democratic Party and their North Korean interlocutors.

Honestly, I don't see how trading in a government that "oppresses" its citizens, for one that puts its citizen's lives at stake-along with those living in every other free, capitalistic South East Asian nation-is such an improvement.

I'm curious about the Jenkins story.

Correct me if I'm wrong, but weren't there four other American soldiers that defected to the DPRK during The Korean War that eventually left, along with the five that chose to remain there?

Yes, a younger generation that didn't experience privation and knows much better than its elders (who earned it) how to properly apportion wealth, away from those who have it and into the hands of those who deserve, all in the sacred name of "social justice." Classic story.

It's the price of plenty. A similar generation of young Americans is now peopling the Democratic party, and its counterpart is ruining the economies of Germany, France, Canada... It will end one of two ways, IMHO - if they run out of stuff to expropriate before they ruin the educational and industrial roots of their economy, their kids will have a chance. If not, and the mighty engine their parents built is plunderable for the course of their political lives, it's going to be a sad, melancholic, nostalgic and resentful Korea that faces 2020 united and broke.

We can't save these folks. We may not even be able to save ourselves.

Personally, I don't see how the Roh government, which, lest you forget, was impeached by a duly elected parliament, is any less corrupt than it's right wing predecessors in the 1980s.

In fact, Kim Dae Jung's entire "Sunshine Policy" was the result of corrupt deals entered into by Kim's Millennium Democratic Party and their North Korean interlocutors.

Definitely. Probably more corrupt.

Yes, they remind me of the shady figures that populated Willey Brandt's chancellorship during the late 60s/early 70s.

Not only are they communists, but they are dishonest communists.

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