Economy and Trade
Over the past 50 years, South Korea (often referred to in financial markets as Korea) has been transformed from a largely rural and poverty-stricken country into one of the world’s most dynamic economies, and a leading exporter of cars and electronic goods. South Korea’s success is often called the Miracle on the Han, after the river that runs through the 23-million-strong capital, Seoul. This economic success has occurred even though South Korea remains technically at war with North Korea; the three-year civil war between the Communist North and the Western-backed South ended in 1953, without a peace agreement. The South has since lived with the threat that its unpredictable and still-Communist northern neighbor, which in 2006 successfully tested a nuclear weapon, could reignite hostilities. In March 2010, the sinking of a South Korean navy vessel near the disputed maritime border under mysterious circumstances did nothing to defuse tensions.
The South Korean economy is now the third-largest in Asia and the 13th-largest in the world. However, the government must confront serious challenges if the economy is to remain prosperous. These include a rapidly ageing population, structural problems such as a rigid labor market, a general lack of regulatory transparency, and a reliance on manufactured exports. South Korea’s banks hold high levels of overseas debt, with the result that the financial system has been impacted in the aftermath of the global credit crunch.
Economic Policy over 12 Months
The government of President Lee Myung-bak, who was elected in December 2007, came to power promising to roll back the influence of the state. Lee argued that “the Korean economy is too large and too complex to be managed by the government,” and promised to cut corporate and personal taxation, reduce the number of government ministries, deregulate the economy, reform the labor market, privatize state-owned entities, and liberalize foreign trade. The popularity of this policy offering may have reflected widespread unease among South Koreans about the growing economic threat from China and other low-cost Asian producers. While the Lee administration has delivered on some of these pledges, the global financial crisis that broke in September 2008 has derailed others, including the government’s flagship privatization program.
By the start of 2009, and following a dramatic weakening of the economy, President Lee said he was committed to finding policies that would make the recession a shallow one. The president declared a national emergency, and said he would preside over a weekly emergency economic committee consisting of senior policy-makers, to ensure that a four-year investment plan, worth US$38 billion and designed to boost the economy, was implemented. Over 80% of the package was earmarked for green investments, as the country aimed to become a leading clean-tech economy. The country’s eco-friendly credentials were further underlined in July 2009 when the government announced that it was to invest an astonishing additional US$85 billion over five years to support the growth of green industries and technologies.
Following the escalation of the global credit crunch in September 2008, the central bank embarked upon a program of aggressive interest rate cuts. By the end of February 2009, the key interest rate stood at just 2%. Though the market anticipated further cuts in response to challenging credit conditions, policymakers held rates steady for the remainder of 2009.
The steadily improving global economic backdrop significantly improved the export outlook for South Korea’s manufacturers through 2010. However, in February 2010 the finance ministry emphasized that it would maintain its expansionary macroeconomic policy as it sought to further bolster the country’s economic recovery.
A news agency quoted a report from the Ministry of Strategy and Finance as saying that “based on our evaluation of the economy, the government led an active fiscal policy to ease contraction, strengthening the country’s economic growth last year.” The ministry pledged to maintain the policy, citing additional enhancements to its crisis-management ability.
While other countries began implementing exit strategies from the unprecedented levels of economic stimulus put into effect during the global economic slump, South Korean policymakers took the view that any similar move from them would be premature. By 2011 the country’s economy had rebounded and was showing robust growth. Policy switched from stimulating growth to addressing the risks posed by rising inflation across Asia and the country moved to withdraw its stimulus measures.
Reporting in June 2011 on an Article IV consultation visit to South Korea, the IMF welcomed South Korea’s move to address inflationary pressures. It welcomed rate hikes by the South Korean central bank but suggested that further steady tightening of monetary policy was in order. Administrative price stabilization measures taken by the government in 2011 had had some beneficial short term effects, the IMF said, but would be ineffective against price pressure on commodities in the longer term, where prices were being driven by demand and supply issues. Price controls are also not particularly effective at controlling inflation expectations. Monetary policy allied to a flexible exchange rate was the best approach, it said.
Economic Performance over 12 Months
With assistance from the IMF, South Korea recovered from the 1997–98 Asian financial crisis, to record strong growth rates prior to the 2008 global downturn. In 2006 and 2007, for example, the economy expanded by 5.1% and 5%, respectively. However, the global financial crisis that developed in September 2008 hit South Korea particularly hard as a result of its open economy. The economy contracted by 5.6% in the last quarter of 2008, compared with the previous quarter. Exports declined sharply, and this fed through to weaker consumption and investment. Following impressive growth earlier in the year, the economy still achieved growth of 2.2% over 2008 as a whole. In particular, South Korea’s financial markets, with substantial holdings of international debt, felt the contagion of the 2008–09 global banking crisis.
In March 2009, the government said that it expected the economy to shrink by around 2% in 2009, marking the first contraction since the 1997–98 Asian financial crisis. The finance ministry said that around 200,000 jobs would be lost during the course of the year as exports collapsed. However, the government correctly anticipated that exports would pick up later in the year, aided by a sharp fall in the currency; by March 2009, the won had lost 35% of its value against the dollar.
The extraordinary levels of support implemented by governments around the world helped to pull the global economy back from the abyss during the second quarter of 2009. Overseas demand recovered more rapidly than many analysts had anticipated, with the export-orientated South Korean economy a major beneficiary. The country’s economy rebounded, with GDP leaping by 2.9% in Q3 2009 on a quarter-on-quarter basis, its best performance in seven years. Meanwhile, industrial production jumped by 11% on a year-on-year basis in September, the best figure for eight months.
The recovery continued into 2010, with state stimulus spending helping the economy to grow by a seasonally adjusted 1.8% in the first quarter, compared to the previous three months. Though the Bank of Korea announced that the economy grew by 7.8% in the first quarter of 2010 compared to a year earlier—topping forecasts of 7.4%—subdued private sector activity supported many analysts’ views that the interest rate would be held at the highly accommodative level of 2.0% for some time.
The IMF is forecasting growth of 4.5% for South Korea in 2011, which is above the country’s long-term trend growth, easing to 4.2% for 2012. The recent soft patch in economic activity is expected to dissipate in the second half of 2011. Private sector investment in the economy is expected to strengthen in the second half, which will create further jobs and household spending is set to increase into 2012.
Support for Inward Investment and Imports
The South Korean government has a generally positive attitude toward foreign investment, and the administration of President Lee has been particularly keen to improve the investment environment. Certainly, there are various barriers that need to be addressed. The regulatory environment remains opaque in certain areas, while labor laws are overly rigid. Labor relations are also problematic, with large numbers of days lost through strikes relative to other Organization for Economic Cooperation and Development (OECD) countries. Invest Korea can provide assistance to investors.
South Korea is a member of the World Trade Organization, and is striving to liberalize its trade regime. For information on tariffs on specific goods or for other assistance on importing goods into the country, see the website of South Korea’s customs service.
South Korea offers various tax exemptions and other incentives to companies that invest in South Korea. A guide detailing all of these incentives is published on Invest Korea’s website.
GDP growth: 4.5% (IMF, 2011 est.)
GDP per capita: US$30,000 (2010 est.)
CPI: 3% (2010 est.)
Key interest rate: 2% (official, May 2010)
Exchange rate versus US dollar: W1,153.77 (2010)*
Unemployment: 3.3% (2010 est.)
FDI: US112.1 billion (December 31, 2010 est.)
Current account surplus: US$36.35 billion (2010 est.)
Population: 48,754,657 (July 2011 est.)
* South Korean won
Source: CIA World Factbook except where stated