Trade Profile: South Korea's Transformation From 'Hermit Kingdom' to Economic Power

11 MINS READJul 17, 2017 | 09:15 GMT
As dusk falls over Seoul, South Korea's bustling capital, the city's skyline comes to life.
Editor's Note

Global trade is changing. The kinds of multilateral agreements that characterized the postwar years have stalled out over the past two decades, prompting countries and economic blocs to try to negotiate smaller deals with fewer partners. Nations and blocs have more leeway under this new model to negotiate the trade agreements that best suit their interests and to avoid those that don't. Now, more than ever, the future of international trade depends on a country or bloc's defensive interests, offensive interests and underlying factors of production. Our fortnightly Trade Profiles aim to break down these factors to facilitate an understanding of where global trade stands today and where it's headed.
In the fifth installment, we focus on South Korea.

A Snapshot of South Korea
Offensive Interests, Defensive Interests and Factors of Production

Economic Background

For most of its postwar history, South Korea has relied on economic liberalization worldwide to drive its economy. The country, squeezed between larger nations and strapped for natural resources, has used a close relationship between government and industry, as well as a proactive trade policy, to build a resilient economy. Along the way, it shed its reputation as a hermit kingdom to become a global economic power. 

The Korean Peninsula has a long tradition of innovation and development. Its people built the world's first astronomical observatory, developed metal printing presses hundreds of years before Western countries did and launched ironclad ships at the end of the 16th century. But invasion and occupation at the hands of larger, more powerful nations — namely China and Japan — punctuated each era of wealth and development. Given the region's history, it is hardly surprising that South Korea's modern economy emerged rather rapidly after the Korean War, which itself followed World War II and Japan's 35-year occupation of Korea. The tumult of the preceding decades left the peninsula devastated and divided by the mid-1950s. But South Korea managed to turn its economy around. Most of its population still depended on the agricultural sector at the end of the war. By the late 1960s, agriculture supported just one-third of the population, and today, only 1 in 50 Koreans is directly involved with the sector. Within a matter of decades, a poor agrarian nation that depended on foreign aid had become one of the world's largest economies.

Dubbed the Miracle on the Han River, an Asian tiger and a little dragon, Korea's economy thrived. Exports fueled the country's precipitous economic rise, supported by the collaborative relationship between the government and family-led conglomerates known as chaebols. Under authoritarian leadership and a culture grounded in Confucian ideals that dictated familial loyalty, obedience and hard work, the South Korean workforce quickly developed a reputation as one of the world's most diligent and efficient labor pools. In this respect, South Korea resembles Japan, its geopolitical rival and a major economic competitor. The countries' economies, in fact, share many striking similarities. The chaebols, for example, are not unlike Japan's keiretsu. And because arable land is scarce in both countries, each state turned to exports of manufactured goods to drive growth.

Exports fueled South Korea's precipitous economic rise, supported by the collaborative relationship between the government and family-led conglomerates known as chaebols.

Seoul emphasized manufacturing initially as part of an import substitution strategy, instating tariffs and non-tariff barriers to discourage competitors from flooding the South Korean market with their goods and services. Once the country's domestic manufacturing sector had developed, the government then facilitated favorable conditions for its own exports. The composition of South Korea's exports has evolved in phases, starting with garments and textiles in the early postwar days before graduating to construction, heavy industry and chemicals in the late 1960s through the 1970s.

Around that time, South Korea's automobile sector also began to take off. The government first began increasing the assembly of foreign vehicles in the country through tax incentives and tariff adjustments, but by 1976, Hyundai Motor Co. was rolling its own models off its assembly lines. Other South Korean car companies such as Kia Motors later established themselves as household names as well. In an effort to control every aspect of the export process, Hyundai entered the shipbuilding sector in the 1970s. Fellow chaebols including Daewoo and Samsung Electronics followed suit, helping to make South Korea one of the world's leading shipbuilders.

The government changed course after the global oil crisis of the 1970s, and in the next decade, South Korea delved into the electronics sector. As they had previously with heavy industry, local companies at first partnered with foreign firms to learn the ropes of electronics manufacturing. From there, the chaebols took advantage of their close ties to Seoul, access to government capital and efficient workforce to excel in the industry. South Korea was one of the world's largest producers of dynamic random-access memory, or DRAM, by the mid-1990s. Today, Samsung and LG Electronics Inc., two of the country's largest chaebols, are leaders in high-tech consumer products.

But the strength of its conglomerates belied the weaknesses lurking in South Korea's economy. In 1997, the Asian financial crisis brought the cracks in the Korean system to light. The government targeted the chaebols that had driven its economic rise for reform. Even so, the companies' well-established manufacturing, automotive and shipping interests enabled South Korea's quick recovery from the crisis. Chaebols, moreover, are still the most competitive employers in the country today; on average, employees of small and medium-sized enterprises receive just 63 percent of what workers employed by the large conglomerates earn.

As South Korea's economy has evolved over the decades, Seoul has steadfastly protected the agricultural sector that once drove it. Farmers and fishers receive just under half of their income on average from government support. (Relative to other countries in the Organization for Economic Cooperation and Development, South Korea provides one of the highest levels of aid to its agricultural producers.) Seoul maintains high prices on agricultural goods in part to sustain the payments, designed to keep agricultural workers' incomes comparable to the constantly improving wages of urbanites. And because of its dearth of arable land, South Korea still struggles with a supply deficiency nearly as large as its total trade surplus. The country depends on agricultural imports to fill the sizable gaps in its domestic production.

Trade Implications

Trade Strategy

For most of its postwar history, South Korea relied on multilateral systems to govern its international trade. Over the past decade, however, the country has turned increasingly to free trade agreements, putting it at the vanguard of the global transition away from broad multilateral deals. (Its geopolitical position as a small country wedged between larger powers has always pushed South Korea to the forefront of economic shifts to defend its own tiny market.) Today, free trade agreements have become a key part of its national economic strategy. Expanding its network of trade deals is necessary to advance South Korea's economic well-being while countering competitive pressure from Japanese and Chinese firms and adapting to the demographic changes in the South Korean workforce.

South Korea has aggressively pursued free trade deals with countries large and small to sustain its booming exports market and to keep up with regional competitors. Its negotiations with smaller trade partners typically focus on diversifying its market access without jeopardizing its interests. South Korea's free trade agreement with Singapore, for instance, left out agricultural exports. Its trade pacts with larger nations, meanwhile, in part reflect its national security priorities, including fortifying its strategic relations with major powers such as China and the United States. And its efforts have paid off. Roughly 70 percent of South Korea's exports enjoy unobstructed access to overseas markets.

South Korea has aggressively pursued free trade deals with countries large and small to sustain its booming exports market and to keep up with regional competitors.

But the country's economy is approaching another crossroads as social inequality grows, private consumption declines and exports slow in key industries such as automobiles and shipbuilding. These changes could cause Seoul to shift its trade strategy, for example by promoting more small and medium-sized domestic enterprises to make up for the declining efficacy of the chaebol structure. Nevertheless, the same core group of sectors that spurred South Korea's miraculous growth over the past 50 years will continue to guide the free trade agreements it negotiates down the line.

Offensive Interests

A staple of South Korea's economy, the shipbuilding industry is one of the country's main offensive interests. Low wages and the distinction as a strategic industry helped the sector thrive initially. The South Korean shipbuilding industry benefited further from a decline in Japan's competitiveness in the years between the 1997 and 2008 financial crises and from globalization when Seoul gained partial ownership of some shipyards in Europe. But today, shipbuilders in South Korea and around the world are still struggling to recover from the 2008-09 slump, which caused a prolonged dip in demand for global shipping and led to an oversupply of ships. Low oil prices, too, are hurting chaebols such as Daewoo that build offshore oil rigs in addition to their other activities. The sector has endured heavy layoffs and substantial losses recently, though the South Korean government has propped up the industry, giving Daewoo, for example, a $2.6 billion bailout in April. As the global shipping sector slowly rebalances and regains its strength, South Korea will continue working to lower barriers to its shipbuilding industry in trade negotiations.

Its future, however, lies in electronics and high-tech manufacturing. South Korea will maintain an offensive stance in this sector, seeking out new markets for its tech products to compete with long-standing rivals such as Japan and emerging challengers such as China. Seoul, like Beijing, is in the throes of an economic transition, the effects of which are likely to be most pronounced in the technology sector. After relying on partnerships and financial advantages to advance its economy, South Korea is starting to emphasize innovation and creativity. To that end, the country may turn toward small and medium-sized enterprises instead of chaebols. Doing so will probably require reforms, as will addressing South Korea's high levels of youth unemployment. And in the wake of these prospective reforms, Seoul may pursue measures in future trade deals to protect its smaller companies in their quest for innovation.

Compared with its other offensive interests, South Korea's automotive sector is more complicated, considering it is also a defensive interest. The government has implemented defensive safety and environmental standards to keep foreign competitors out of its tiny domestic market. But because South Korea's market is too small to sustain its automakers, Seoul has also worked to increase its market share overseas by reducing barriers to its vehicles through trade negotiations. The country's passenger vehicle exports soared after the Asian financial crisis, nearly quadrupling from 2001 to surpass $44 billion in 2014 (though they have since fallen, dipping below $38 billion in 2016). In the process, South Korean automotive manufacturers found themselves in more direct competition with companies in the United States, Europe and Japan. Some of South Korea's trade partners may object to its non-tariff barriers, especially if they turn trade flows in Seoul's favor. Already, U.S. President Donald Trump's administration has highlighted the automotive sector as one of the shortcomings of the free trade deal the United States signed with South Korea in 2012. (Washington intends to renegotiate the pact, as U.S. Trade Representative Robert Lighthizer announced July 12.) The challenges the sector's offensive and defensive interests pose have encouraged Seoul to largely exclude the automotive industry from certain trade agreements, such as the one it recently closed with Beijing. 

Defensive Interests

As for its more straightforward defensive interests, agriculture is still the most sensitive sector for South Korea, despite its small contribution to the country's economy. Seoul relies on high tariffs — nearly 60 percent — along with tight quotas and restrictive regulations on agricultural imports to insulate its domestic sector, especially rice, meat and dairy. In previous free trade deals, South Korea has negotiated to gradually open its market, for instance through schedules to phase out tariffs and non-tariff barriers on select fruits and vegetables. Rice, on the other hand, is a perennial exception because of its central role in the government's efforts to maintain self-sufficiency in grain. Now that the country's farming community is rapidly shrinking, South Korea will have to turn to technological advances such as automation to keep up its domestic agricultural production, however small it may be. It may even have to liberalize the sector. Down the line, these considerations are likely to factor into discussions on free trade agreements.

South Korea's service sector, too, is closely protected since it has largely underperformed relative to other domestic industries and to the service sectors of other developed economies. (Labor productivity in the South Korean service sector is about half that of the U.S. industry and 70 percent of that of Japan.) As the country's manufacturing exports mature, though, a more robust service sector could help compensate for its flagging automotive and shipbuilding industries while also accommodating its aging population and rising income inequality. With that in mind, Seoul has attempted to reform the industry to try to stimulate productivity, support small and medium-sized enterprises, and encourage the development of modern industries such as health care, telecommunications and legal and financial services. South Korea's government has also used free trade negotiations to slowly open up its service sector to overseas providers in hopes of facilitating structural changes at home. Its recent trade deals with the European Union and United States exemplify its strategy to promote services trade across a range of areas, including express delivery, telecommunications and broadcast.

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