South Korea Poised for Economic Disaster

As the year comes to a close, special attention must be paid to the South Korean economy. Sure, the presidential scandal is stealing the headlines but there might be something even worse lurking around the corner: an unprecedented economic slide. The scandals aren’t helping, of course, affecting currency exchange rates, stock prices, and the government’s ability to do business but that’s not where the real problem is. The real problem is in the fundamentals of the Korean economy.

Let’s start with a simple analysis of what actually comprises the Korean economy.  In 2015, about 46% of South Korea’s GDP was due to the export of goods and services. Let that number sink in for a moment. That means about half of Korea’s entire economy relies on exports. Believe it or not, this figure is actually down from the peak of 56% experienced in 2012. By comparison, only about 13%, 18% and 22% of the US, Japanese and Chinese economies, respectively, depend on exports. All three of these latter countries have stronger domestic consumption to balance exports, The Diplomat reported.

The problem with a heavy dependence on exports is susceptibility to global competition. Although domestic markets can be protected in various ways, market shares in other countries are vulnerable to changing tastes, new competitors, and undercutting imitations that offer a similar product at a lower price.

The most prominent Korean exports in the last two decades have been electronics, automobiles and boats. In the mid 2000s, Korea was a (if not the) global leader in each area. In recent years, however, Korean prominence has been significantly diminished across the board, in large part due to the emergence of Chinese companies who have caught up in expertise, now able to offer comparable products at a lower price in a growing number of markets.

One of the important aspects that gets missed about Korean exports is their overall lack of diversity. About 48% of all Korean exports consist of electronics and related components while 31% are transportation goods (cars, boats, and related parts). A game-changing shift in the playing field for any product area could spell a slow but steady downward spiral for the entire economy. Even a 10% drop in exports would literally shrink the economy by 5%, costing tens of thousands of jobs that ultimately depend on export revenue, exacerbating the already high underemployment rate of 14% and youth unemployment rate of 9%.

 Zombie Companies

Another key area of concern is corporate debt. South Korea’s total corporate debt is worth about 171% of its GDP. Although this high percentage is not unique to Korea (the US and China have about 304% and 169% respectively), Korea is more susceptible to adverse consequences for a number of reasons.

The first is the high prevalence of “zombie companies”, corporate entities that have been unable to repay debt for at least three years running. It is estimated that about a quarter of all Korean corporate debt is held by zombie companies, unlikely to ever be repaid.

Korea had an economic boom in the late 1990s and 2000s. This period created a wealth of capital in Korea, money that begged to be invested somewhere. To promote investment domestically, the Korean government successively loosened lending laws so Korean companies could borrow more than perhaps they should have been allowed to. This loosening is one of the key ingredients that allowed for the creation of so many zombie companies, with eerie parallels to the bad debt that prompted the 2008 global meltdown.

A notable beneficiary of corporate lending for the last three decades has been the Korean real estate market. Korea’s property market has witnessed the construction of hundreds of new apartment complexes, resorts, and luxury hotels.

This investment has continued in 2015 at a record pace, despite the fact there has been a serious housing glut in recent years with tens of thousands of apartment units remaining empty, prompting concerns about the inevitability of a substantial property bubble.

Korea’s household debt has continued to balloon: from 84% of GDP in January 2015 to 90% by July of this year. By comparison, China has only about 41% household debt by GDP while Japan has 66%.