KOREA ECONOMIC INSTITUTE OF AMERICA
Volume 1, Number 6 -- September 1999

The Korean Economy in an Era of Global Competition
by Lawrence Krause

     Korea has completed the first two tasks in recovering from the Asian Financial Crisis�it has stabilized financial markets and it has initiated a strong rebound in the real economy. Questions have been raised as to whether this recovery is sustainable. In my view it is because the external situation is favorable and this combines with some encouraging domestic developments.

     The immediate period of growth has permitted a widespread recovery of profits. This in time will permit investment to recover. With the stabilization and rise of semiconductor prices, corporate profit growth should continue. Second, the recovery of intra-Asian trade is encouraging for Korea. This was the fastest growing market for Korean exports before the Asian Financial Crisis, and its recovery will help sustain export growth. Third, economic growth continues in the United States as far as the eye can see, and faster growth is now being signaled in Europe. Latin America has suffered a downturn, but is now recovering. Japan remains a question mark, but there is now less concern over a possible collapse, and the yen is strong.

     The supportive external environment is being enhanced by expansionary domestic policy, both fiscal and monetary. While the National Assembly elections in April 2000 may add some uncertainty, it also likely means that policy will not change.

     Now Korea is moving into circumstances where action is not only difficult, but is also much more complex. Four areas have been identified as needing reform;

• the financial system
• corporate governance (the chaebol issue)
• the labor market and industrial relations
• the political system

     Korea's priorities are unclear, and the methodology needed to achieve complex goals are far from standard or text-bookish. An obvious question arises because there is so much to do, what are the priorities for action, and what methods will be used? It is comforting to note that economic recovery need not await completion of these reforms, although continuation of economic progress may depend on moving in the proper direction.

A Vision for Korea

     It is my belief that Korea needs an articulated vision of what sort of society it wants to be. In the past, Korea had the political processes of China, and the economic model of Japan. The Korean people rejected the old political system in 1987; and, after some spectacular successes, the economic model failed in 1997. A vision is needed to replace these because a vision becomes a fixed direction to set priorities and to give guidance to methods.

     A problem in Korea is that Koreans have not read or do not believe in the writings of Joseph Schumpeter. He popularized the notion of creative destruction. A recession results in downsizing which creates the conditions for a rapid recovery and resumption of growth. It is the down-sized employees who will become the entrepreneurs of tomorrow, and the economy desperately needs entrepreneurship.

     Let me suggest that the United States may well not be the model for Korean society. The United States has a disparate ethnic mix, which is constantly changing as a result of legal and illegal immigration. The United States is a constantly changing society, even a revolutionary one. Hence, village elders or trusted community leaders cannot mediate disputes. Legal processes are at the center of U.S. social stability. Korea is much different. It is essentially a homogeneous people which permits more personal relationships to function.

Is Macro Recovery Helping Resolve Structural Problems?

     The robust rebound in the Korean economy should be helping relieve problems, but where? It doesn't seem to matter to the commercial banking system since the recovery was not bank financed. It certainly does not relieve the huge debt/equity problems of the major chaebol. The chaebol governance issues are still there. Labor market and government reforms are not being promoted, and may even be set back.

     What the recovery is doing is revitalizing certain firms and certain industries. It is pointing the way toward which the Korean economy should evolve. Enterprises that are succeeding now have gained strength from knowing that they survived the crisis. This may be the new model for Korea.

Dr. Krause is Pacific Economic Cooperation Professor emeritus in the Graduate School of International Relations and Pacific Studies at the University of California, San Diego.

Jobless Rate Declines: According to the National Statistical Office, Korea's unemployment rate fell to 5.7% in August, down from 6.2% the previous month and 7.6% a year earlier. This is the first time in 18 months the unemployment rate has fallen below 6%. Unemployment had hovered around 2% before the onset of the economic crisis in 1997. The government expects this year's jobless rate to stabilize at 6.5% on average, compared with 6.8% last year.

Household Spending Nearing Pre-Crisis Levels: Household spending rose 6.3% year-on-year in the first quarter and jumped 9.1% in the second quarter for a first-half growth rate of 7.7%. The Bank of Korea said first-half household consumption reached 96% of pre-crisis levels. Due to rising unemployment and a subsequent fall in household income, spending declined to 89.2% in the first half of last year and to 91.2% in the second half. But it rose to 95.6% in the first quarter of this year and to 96.7% in the subsequent quarter. The central bank predicted a continued rise in household spending, but warned that excessive consumer spending could lead to the worsening of the nation's current account balance and inflation.

Korean Car Exports on the Rise: Korea's auto exports have been accelerating, with more than 1 million vehicles shipped overseas so far this year. The Korean Automobile Manufacturers Association expects that a total of 1.57 million autos will be exported this year. Exports of Korean-made passenger cars to the United States have been also rising steeply. Hyundai Motors announced that its auto shipments to the U.S. for first eight months of this year jumped 68% over the same period last year. Kia also reported that its passenger models rose more than 30% for the same time period. Daewoo said it has been enjoying average monthly sales of 4,000 units since the beginning of the year.

Gross National Income (GNI) Surges: The Bank of Korea reported that Korea's real GNI increased 7.7% to 97.8 trillion won in the second quarter from a year earlier. Nominal GNI had been on decline since rising 7.2% in the first quarter of 1998. By industry, the manufacturing sector's GNI rose 6.4% year-on-year, while agricultural, fisheries, and forestry industry reported a 24.8% jump. The service sector saw a jump of 7.3% but the construction sector's GNI declined 2.8%. The central bank attributed GNI gain to the faster-than-expected recovery of the economy.

U.S. POLICY PERSPECTIVE
by Caroline G. Copper

Easing Economic Sanctions Against North Korea Faces Uphill Battle in Congress: Just days after the Perry Report was released to Congress, the President announced on September 17 that economic sanctions against North Korea would be eased. Following the announcement, former Secretary of Defense William Perry said in a CNN news interview that the decision is a necessary first step in exchange for assurances that North Korea will suspend future missile test firings. Perry commented that "there is substantial mistrust...on both sides...and it is important, therefore, that we move forward a step at a time in this process and not try to make a broad package deal because of this level of mistrust." By easing sanctions, U.S. firms will be able to export consumer goods and financial services to North Korea, as well as invest in North Korean agriculture, mining, petroleum, timber, cement, transportation, infrastructure, and travel. In turn, North Koreans will be allowed to export certain goods to the United States, as well as travel to the United States. On Capitol Hill, the news was not well received, particularly by Republicans. Both House International Relations Committee Chairman Gilman and Senate Foreign Relations Committee Chairman Helms opposed the decision. Speaker Hastert recently appointed Chairman Gilman to lead a North Korea Advisory Committee. There is uncertainty as to the next step of the Committee, but Hill staffers intimate it will be a tough road ahead. Many were caught off guard by the announcement and comment that their bosses should have received fairer warning.

Steel Trade Debate Not Over in Congress: Over the last month, Members and Senators have stepped up efforts to assist the faltering domestic steel industry. On September 9, the American Iron and Steel Institute held a trade briefing on Capitol Hill to shore up support for H.R. 1505, The Fair trade Law Enforcement Act of 1999. This legislation, introduced by Rep. Phil English (R-PA) seeks to accomplish four main objectives: update Section 201 of the 1974 trade law; enhance the effectiveness of antidumping and countervailing duty laws; address the problem of suspension agreements; and create a WTO program to track steel imports. English says the bill is "a last line of defense for a number of U.S. industries." Earlier this month, a report on S. 1254, the Steel Trade Enforcement Act of 1999, was completed by the Senate Finance Committee and sent the Senate floor. This bill, introduced by Senator Max Baucus (DMT), seeks to accomplish many of the objectives outlined in H.R. 1505, but goes one step further by requiring USTR to come up with a comprehensive strategy to tackle steel import surges. In addition, the legislation instructs U.S. representatives to international financial institutions to ensure that no funds are lent to countries for the purpose of expanding existing steelmaking capacity. Finally on September 22, Rep. Peter Visclosky made another attempt to heat up the steel debate by introducing H.R.298, the Maintain United States Trade Law resolution (MUST). This legislation calls on the President to ensure that the United States will not alter its trade laws during the upcoming WTO round. In his floor statement, Visclosky commented that "throughout the steel crisis, antidumping and countervailing duty laws have represented one of the few means of relief for American steel workers. It is imperative that the administration uphold these important trade laws at the WTO Seattle Round."

Source: U.S. Department of Commerce

NEWS HIGHLIGHTS
by Shelby K. Mamizuka

Korea Herald, "Daewoo Signs Agreement to Retain Only Six Units" (August 16): The Daewoo Group and its domestic creditors signed a sweeping restructuring plan which will virtually break up the chaebol. The group will have its empire whittled down to only six auto-related subsidiaries by the end of this year in order to avert a serious insolvency crisis, Korea First Bank said. The six units to be retained are Daewoo Motor Co., Daewoo Motor Sales Co., Daewoo Telecom, Daewoo Capital Co., the trading division of Daewoo Corp. and Daewoo Heavy Industries' machinery unit. The subsidiaries have combined assets of 56 trillion won, a net worth of 23 trillion won, debts of 33 trillion won and a debt-to-equity ratio of 196%. Under the plan, Daewoo will sell Daewoo Securities Co. and Seoul Investment Trust Co., as well as Daewoo Electronics and its shipyard and construction businesses. The creditor banks, however, said that the fate of Daewoo Motors will depend on its negotiations with General Motors. Analysts viewed the restructuring program for Daewoo as the manifestation of the Kim Administration's resolve to reform the chaebol.

Korea Herald, "Top Five Chaebol Chiefs Agree to Government Reform Plan: President Blames Daewoo, Urges Thorough Restructuring" (August 25): Bowing to government pressure, Korea's top five chaebol yesterday agreed to end their "fleet-style" operation and accept three new reform requirements outlined by the government. The agreement was made in the presence of President Kim, who called in the heads of the chaebol and their creditor banks to expedite restructuring of the chaebol. The President outlined his new reform initiatives aimed at restricting the chaebols' control of the non-banking financial sector, barring them from circular cross-unit equity investments and inside trading and limiting illegal inheritances and transfer of wealth among the chaebol family members. The Chong Wa Dae meeting drew additional public attention because of the current crisis at the Daewoo Group. The agreement did not mention Daewoo but unequivocally pinpointed the group as a "troublemaker," saying restructuring at all but one of the five chaebol has been going as scheduled. President Kim himself blamed Daewoo for causing the problems, saying that it has failed to earn domestic and foreign markets' confidence in its restructuring program. "I hope that Chairman Kim, as the head of Daewoo, will assume his social responsibility and make efforts to meet public expectations by implementing due restrucuring," Kim said. "The government is not intervening in corporate reforms because it is fun," Kim noted, adding that direct and indirect intervention by the government is inevitable in emergencies. The President, however, emphasized that his government was not seeking to break up the chaebol. The Chong Wa Dae agreement said the despite the recent recovery, the structure of the Korean economy was still not strong enough to withstand any negative change in economic conditions.

Joong Ang Ilbo, "Korea Repays Total of $13.4 Billion SRF Loans to IMF" (September 17): The Korean government has repaid a total of $13.4 billion short-term supplementary reserve facility (SRF) debts to the IMF. Therefore, the remaining IMF loans take the form of a low-interest and long-term stand-by arrangement. The total owed will reach $7.5 billion next year, when the IMF is scheduled to lend a further $1.5 billion to Korea. An official said, "The complete repayment of the SRF debts means that Korea has successfully overcome its economic crisis because the SRF is offered to resolve serious immediate shortages of foreign exchange reserves."

Chosun Ilbo, "Banks Write-off More Than 2 Trillion won in Bad Debts" (September 23): Korean banks wrote off more than 2 trillion in bad debts in the first half of the year, according to the FSC today. The amount includes 1.6 trillion won in money that had been owed by nation-wide commercial banks and 445 million won owed by regional banks. Korea First Bank wrote off the largest amount of bad debts, 543 billion won, followed by Hanvit Bank, 276 billion won.

BUSINESS UPDATE
by R. Ben Weber

Korean Semiconductor Sales to top $20 billion: Sales of Korea's semiconductors are expected to surpass $20 billion for the first time in four years. Demand for the popular 64M DRAM chip has been extremely strong according to the Samsung Economic Research Institute (SERI). In addition, the recent earthquake in Taiwan is also expected to effect the chip market as supplies are lower due to damage to Taiwan's manufacturing plants. With the year 2000 less than 100 days away, new computer purchases by consumers seeking to rid themselves of older models have also increased dramatically. This has led to a 200% price increase in the U.S. semiconductor spot market since July. Korea's semi-conductor exports currently account for 10% of its total exports.

Foreign Direct Investment into Korea surges 200% in August: This past August, Korea registered 173 new FDI projects that totaled $1,231 million, up 202.5% since August of 1998. To date, the eight month total for FDI into Korea is $7,774 million, up 89.5% from the same time period last year. ING Insurance of the Netherlands invested $280 million in the Housing & Commercial Bank, the largest investment this year. Japan is second with a $200 million investment between Japan Korea Joint Smelting and LG Nikko Cooper, Inc. The largest U.S. investment was by Seminis which has invested $47 million in Hung Nong Seeds. Europe continues to dominate FDI in Korea. However it is expected that the United States will overtake Europe as many large deals, such as Daewoo and GM, complete their negotiations by year's end.

Newbridge Capital and the Financial Supervisory Commission sign TOI on the sale of Korea First Bank: On September 17 th , representatives of Newbridge Capital signed the Terms of Investment with the FSC over the sale of Korea First Bank. After months of negotiations with the Korean government, Newbridge Capital is well on its way to becoming a majority shareholder of Korea's largest banking network. Newbridge Capital will invest 500 billion to purchase 51% of Korea First Bank from the government. The Korean government has guaranteed warrants that will enable the procurement, after three years, of 5% of the total outstanding common shares. Finally, the Korea Asset management Corp. will acquire all of Korea First Bank's non-performing loans, while Korea First will purchase the remaining normal and precautionary loans.

Korea Insight is published monthly by the Korea Economic Institute. Vice President Joseph A.B. Winder is the editor.

ECONOMIC INDICATORS
by Florence Lowe-Lee

Usable FX Reserves ($ billion) Exchange Rate/Won $ Stock Price Index (1980=100) Interest Rate (3 years bonds) Industrial product. (1995=100) Unemployment Rate (%) Source: Bank of Korea GDP Growth (%) Consumption Growth (%) Domestic Invest. Growth (%) Trade Account ($billions) Current Account ($billions) FDI Inflows ($billions)

1997 1998 1999 Ju n Dec Jun Dec Jan Feb Mar Apr May Jun Jul Aug   8.9 37.0 48.5 50.1 52.0 54.5 56.4 58.7 60.4 64.0 64.8 88 8 1415 1385 1208 1175 1222 1225 1176 1186 1156 1207 1185 76 5 390 313 525 598 533 586 721 745 841 971 933 11. 7 24.3 16.6 8.3 7.9 8.6 8.6 7.6 8.3 8.1 8.6 9.9 11 6 116 99 122 111 104 125 124 126 130 131 na 2.3 3.1 7.0 7.9 8.5 8.7 8.1 7.2 6.5 6.2 6.2 5.7   1998 1999 1995 1996 1997 1998 1st Qtr 2nd Qtr 3rd Qtr 4th Qtr 1st Qtr 2nd Qtr 8.9 7.1 5.5 -5.8 -3.9 -3.9 -6.8 -5.3 4.6 9.8 8.2 7.2 3.3 -8.2 -8.4 -9.7 -8.9 -5.8 5.0 7.2 11.9 7.3 -2.2 -21.1 -20.6 -23.7 -22.2 -17.9 -4.3 4.9 -4.4 -15.0 -3.2 41.6 9.8 11.4 10.2 9.7 4.8 7.2 -8.5 -23.0 -8.2 40.0 10.9 10.9 9.6 8.7 7.1 6.5 1.9 3.2 7.0 8.9 0.6 1.9 2.2 4.2 2.0 2.5

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