Country Report South Korea
South Korea’s economic momentum has been improving, as on the back of higher consumption and government spending the economy grew by 0.9% quarter-on-quarter in the third quarter of 2014.
Strengths (+) and weaknesses (-)
(+) Well developed and diversified economy
South Korea’s economy is the 14th-largest in the World with a relatively high GDP per capita. It has a strong, diversified and internationally highly competitive industrial and manufacturing base.
(+) Strong democratic institutions
Underpinned by a mature and stable democratic system, South Korea has relatively strong institutions. Especially the rule of law, regulatory quality and government effectiveness are solid.
(-) Relations with North Korea
The Korean War ended in 1953 without a formal peace-treaty and the countries are thus still officially at war. As a result of highly erratic and at times aggressive behaviour of North Korea, tensions flare up from time to time, while a collapse of North Korea could result in very high re-unification costs for South Korea.
(-) High household debt
Korea’s households have increased their borrowing over the past decade. Korea’s household debt to GDP ratio has risen from 62.3% in 2008 to 71.5% in 2013, which is similar to the most indebted advanced economies in the world.
1. Economic momentum improves
South Korea’s economic momentum has been improving, as on the back of higher consumption and government spending the economy grew by 0.9% q-o-q in the third quarter of 2014, up from 0.5% qoq in the second quarter. The economic expansion was a result of an increase in consumer spending (1.0% qoq), as consumer confidence picked up in the third quarter. Consumer confidence dropped in May, as a result of a ferry (Sewol) in April whereby more than 300 people died. Government spending increased by 2.3% qoq, after a stimulus package had been announced in July. The package is worth around USD 44 billion (3.2% of GDP) of which two-thirds was already spent by the end of 2014. Growth was restricted by a negative contribution of the external sector, as exports fell by 2.2% qoq, while imports shrank by 0.2%.
South Korea’s economic outlook also improved. First, consumer spending is expected to increase further, as borrowing costs have decreased. This relates to the fact that the Bank of Korea lowered its policy interest rate in October for a second time in 2014 to 2%. The positive impact of a lower interest rate is restricted by the already high level of household debt. Second, exports are expected to rise on the back of an improving US economy. For 2014, the South Korean economy is expected to have grown by 3.5%, while GDP is expected to expand by 3.7% this year (figure 1). For the longer term, President Park is trying to boost South Korea’s economic growth potential by a Three-Year Plan for Economic Innovation. The plan includes 1) improving the overall regulatory environment and removing red tape 2) reducing the level of debt in public organisations 3) boost domestic demand and 4) increase the labour participation of women and the youth. Rising the participation rate is important since South Korea will be confronted by ageing (figure 2). Currently 73% of the population is between 15 and 64 years old but this figure will decrease to less than 50% in 2060. Finally, the number of SME’s that will be labelled as potential (export) champion will be increased from 634 in 2014 to 1150 in 2017.
2. Political party disbanded
In December, the Supreme Court ruled that the United Progressive Party (UPP) had to be disbanded, as the party was violating the basic principles of democracy. Due to the ruling the UPP also has to give up its five seats in parliament. The government had asked the Supreme Court to disband the party, after the party had secretly organised a meeting in May 2013. During the meeting the party discussed possible attacks against South Korea's utilities in case a war between the two Korea’s would break out. The Supreme Court ruled against the UPP with 8 against 1, while 6 votes were needed to ratify the decision. A lawmaker from the UPP, Lee Seok-ki, still awaits for his appeal against a 12 year sentence for organising the meeting. In a comment, Amnesty International expressed its concerns that national security was used to repress the political opposition.
3. Talks or no talks with North Korea
Relations with North Korea remain difficult and uncertain. On 8 January, North Korea rejected an invitation from South Korea’s parliament to restart talks about human rights in North Korea and re-unification of Korean families. This is a setback as Kim Jong-un, the North Korean leader, surprisingly said in his New Year speech that he was open to a high-level summit with South Korea. Another offer from South Korea to hold talks later in January remained unanswered.
In December, South Korea was also confronted by cyber-attacks on its nuclear plants. President and CEO Cho Seok of Korea Hydro & Nuclear Power Co Ltd said that the plants were still operating safely. South Korean prosecutors have started an investigation in cooperation with the Chinese authorities, as the attacks were linked to a Chinese city close to the North Korean border. The North Korean authorities however deny that they were involved in the attack. Tensions between the United States, a South Korean ally, and North Korea have also been rising after the US accused North Korea of cyber-attacks on Sony. It is however still unclear whether North Korea is indeed responsible for the attack. Nevertheless, the US imposed additional sanctions on North Korea following the Sony cyber-attack.
South Korea is a high-income country with a strong industrial base. South Korea is the 14th largest economy in the world and a member of the G20 and the OECD. After South Korea adopted an outward-looking strategy in the second-half of the 20th century, in which growth and development were supported by labour-intensive manufactured exports, the country industrialised rapidly. The industrial sector still remains the backbone of the South Korean economy. From the 1990s onwards, South Korea’s manufacturing sector expanded into other, more high-tech areas such as microelectronics and microbiology. The importance of the export sector to the South Korean economy does, however, increase the country’s vulnerability to external developments. As a result of continued focus on business friendly policies, the country is ranked 7th out of 183 countries on the ease of doing business index.
A constitutional change in 1987 laid the foundation for the current stable multi-party democracy. South Korea’s political and business environment is dominated by close personal relationships and a strong influence of chaebols (large business conglomerates). The downside of this is economic nationalism and corruption. Since fighting between North and South Korea ceased in 1953 without a formal peace-treaty, the tense and uneasy relationship between the two nations remains an important downside risk. Tensions flare up from time to time, usually due to provocations initiated by the North Korean regime.