South Korea's difficult economic environment won't just make it harder for President Moon Jae In to enact his political agenda; in the next few months, it will threaten the continuity of his government. As with the rest of the Asia-Pacific, South Korea's economy is contending with slackening global demand, the volatile U.S.-China trade war and a cooling Chinese economy. The legislative elections that risk turning Moon into a lame duck take place in April 2020, and until then, he will have to balance carefully between delivering on promises to his supporters and buoying economic growth. This means he will have to rely more on the family-run conglomerates known as chaebols that dominate the South Korean economy to both support growth and build resistance to global trade disruptions. He will also take a more defiant stance against Japan amid their trade skirmish — a popular stance among his base within the South Korean electorate.
South Korea's export-led economy is groaning under the weight of global economic sluggishness and trade disruptions. This presents hurdles for the government of President Moon Jae In, jeopardizing his long-term political prospects and progressive political promises.
The Gathering Storm
South Korea's export-reliant economy makes it particularly vulnerable to the global slowdown and trade risks. The Chinese and U.S. markets, which respectively account for 24 percent and 12 percent of South Korean trade, hold particular importance for its economy, meaning that it's particularly sensitive to their trade tussle. Their trade issues, combined with the global slowdown in demand, have pushed South Korean exports down for 10 straight months, as measured year-on-year, including a 13.6 percent decline in August as its exports to China fell by more than 21 percent. Preliminary September figures show a continued decline of 11.7 percent. Adding to the economic pressure on South Korea has been the massive and sustained cyclical global decline in semiconductor sales and prices in 2019 driven by the combination of oversupply, overcapacity and contractions in demand for mobile devices, computers and data centers. On top of this, South Korea's chipmakers are facing the added headache of the trade war with Japan, which has brought export restrictions on the supply of chemicals they need for manufacturing. A dip in semiconductor exports of 31 percent in each month led to the overall export declines. Exports of integrated circuits made up an 18 percent share of South Korea's total in 2018, contributing 92 percent to export growth.
The export contraction has led the government to downgrade its growth forecasts, with the central bank saying in September that the gross domestic product in 2019 will likely fall below the 2.2 percent target. Standard & Poor's meanwhile, is projecting 1.8 percent growth. This deepens a slowdown already seen in 2018 when growth was only 2.7 percent, the slowest in six years. South Korean unemployment hit a nine-year high at the start of 2019 of 4.4 percent and clocked in at 4.1 percent in the second quarter (the rate was 3.7 percent when Moon assumed office in 2017). Although August brought a bright spot, with the overall unemployment decreasing to hit a monthly rate of 3.1 percent, much of that gain can be attributed to a singular government push to hire older workers that cushioned employment declines in the crucial manufacturing and retail sectors. Chronic joblessness, too, has dogged the South Korean economy and, among those younger than 24, the jobless rate was 10.4 percent in June — up 1 percent year-on-year. The unemployment trend and high levels of household debt have spurred weak domestic consumption, deepening economic issues.
Deflating exports and cooling household demand increase the risk of deflation. A price drop of 0.4 percent in September was the first in South Korean history, following on the heels of flat prices in August. (To officially qualify as deflation, this price drop would need to continue through two consecutive quarters.) Unlike Japan, whose so-called Lost Decades have been dogged by deflation, South Korea has largely avoided wide-scale price declines, and a tip into this trend would risk further sapping demand and economic growth.
South Korea's currency has also been weakening against the U.S. dollar, falling to a two-year low point by midyear and declining by a further 7.6 percent by September. A weaker won is not a benefit for South Korea despite its export-driven economy given a large overseas production base, industrial structural factors and the fact that it will drive up raw material costs. In July, the central bank cut interest rates by 25 basis points — its first trim in three years. Although it held the rate steady in August, another policy review is due in mid-October — with the currency and deflationary pressure making another cut attractive.
Managing the Headwinds
In tandem with economic issues (and stalled outreach to North Korea, a banner issue for Moon), the president's approval ratings have taken a tumble, hitting an all-time low of 40 percent in late September. (They were at 84 percent when he entered office.) Economic woes have caused Moon to back away somewhat from his more ambitious policies and may force him to continue to further slow progress.
South Korea's draft 2020 budget in late August proposes $424 billion in spending, its greatest expenditures since the 2008 financial crisis.
Moon has touted a progressive "income-led" growth policy highly popular with his supporters, meant to boost wages and spur spending. This came on top of corporate income and capital gains tax hikes in 2017 to pay for more government spending in support of small businesses. Over the course of his first two years in office, Moon's government oversaw minimum wage hikes of 29 percent overall, slowing job growth in low-end sectors such as retail and construction. A planned hike of 15.3 percent would have brought the wage to 10,000 won per hour by 2020.
But Moon has since backed off, accepting instead a 2.9 percent increase agreed to by labor union and business leaders — the third-lowest minimum wage hike since 1988. Moon appears now to be largely focused on stimulus measures. South Korea's draft 2020 budget in late August proposes $424 billion in spending, its greatest expenditures since the 2008 financial crisis. This marks an 8 percent year-on-year increase, even when accounting for the $4.9 billion outlay in the 2019 supplementary budget. The 2020 spending will focus on job creation, development of areas identified as potential growth drivers and welfare spending.
The president had also promised a push against the chaebols that dominate the South Korean economy, including pillars of the corporate sector such as Samsung, Hyundai, LG and Lotte. Chaebols have long drawn the ire of political progressives who criticize their opacity, family-run model and monopolies that squeeze small- and medium-sized enterprises in key sectors. President Park Geun Hye's administration collapsed under the weight of a chaebol influence-peddling scandal. After he succeeded her, Moon promised tighter oversight of the chaebols, pledging to increase penalties for economic crimes and tighten corporate governance to weaken the grip of family control. Under his watch, prosecutions of chaebol leaders related to the Park scandals have gone forward. Moon also tasked the Fair Trade Commission with scrutinizing hiring, corporate governance and prices set by chaebols.
A Policy Moderation
But South Korea's economic weaknesses have increased the importance of chaebol-led business. The Japan trade war, in particular, has increased the emphasis on building up domestic South Korean supply chains to better insulate them against cutoffs by export partners. The sprawling, vertically-integrated chaebols will fill an important role here, even as Moon tries to emphasize smaller businesses. South Korea's budget provides $4.1 billion to be invested in 100 critical parts, materials and equipment manufacturers through 2022 to promote the indigenization of key sectors affected by the trade measures. The government will also fast-track approvals for $1.6 billion in research and development projects and provide financial support to companies damaged by Japan's trade restrictions. The appointment in September of Joh Sung Wook to replace the head of South Korea's antitrust Fair Trade Commission who had been known for taking a hard line on chaebols could signal a softening of the body's approach. The newcomer appears more focused on regulating foreign tech company activities in the domestic market and streamlining the investigation process over deepening her agency's scrutiny process.
But this does not mean that Moon has abandoned his progressive economic policies entirely. Some easing back on chaebols and the friction in the Japan-South Korea relationship will present opportunities for alternative sources to fill links in South Korean semiconductor supply chains. At the same time, the Moon administration, seeking a popular target, will emphasize its push against foreign tech giants. However, this is a difficult balance to strike as the 2020 legislative election critical for the viability of his government approach. South Korea's political scene is sharply divided between progressives that support Moon and a substantial conservative camp. Moon will need to be careful not to alienate his supporters by moderating too much.