By Philip Alexander
Even if ratified, Korea’s free trade agreement with the US may be most notable for what was excluded: how to deal with Chinese firms moving swiftly up the value chain
In the first quarter of 2007, the Bank of Korea (BoK) published a number of reports echoing the concerns of Samsung chairman Lee Kun-Hee that efforts by Chinese companies to move up the value chain and develop greater international branding power would begin to erode Korean international market share. Yet officials at the BoK could be forgiven for wondering if investors are listening. Buoyed by the eleventh-hour signature of a free trade agreement (FTA) with the US, South Korea’s benchmark KOSPI share index touched record highs at the start of April 2007.
So, is the central bank simply attempting to return policy-making focus to the economic agenda, even as the ruling Uri party breaks apart in the heated pre-election atmosphere? Takahira Ogawa, South Korea sovereign credit ratings analyst at Standard & Poor’s in Singapore, believes that the China challenge should not be lightly dismissed as a distant one. “If there is a downturn in global trade in the near term, all Asian exporters will be affected, but Chinese companies can use their price competitiveness to increase market share,” he tells Emerging Markets.
However, he emphasizes that China also remains an immense opportunity for Korea, given the right policy response. In this regard, he cites a recent academic study, which suggested that a free trade agreement with China could bring benefits to the Korean economy 10 times as great as those of the US FTA.
In the balance
To reap these benefits, South Korea will need to maintain competitiveness, but this appears to hang in the balance. The World Economic Forum’s 2006/07 Global Competitiveness Report ranked Korea at 24, down from 19 in 2005/06. To reverse this slide, Ogawa believes efficiency gains could be driven by further liberalization in the labour market, and in service sectors such as retail, education and healthcare. These politically sensitive measures are unlikely before the presidential and parliamentary elections in December 2007 and April 2008, respectively. Moreover, the services sector was excluded from the US FTA altogether, so no stimulus will come from that quarter.
Richard Evans, co-manager of around £2 billion in equity assets in the Asia Pacific ex-Japan region at Martin Currie in Edinburgh, concurs that the FTA was most notable for its limits, and he points to the autos sector in particular.
“The message seems to be that the autos sector got away with it. The domestic market is still a big source of cash generation for Hyundai and Kia in particular, and it would have been much more negative for them if the market had been fully opened up to price competition from the US,” he says.
Ultimately, he believes that a gradual transition to freer trade in the sector is inevitable. He is concerned that the ability of Korean auto manufacturers to respond is constrained by poor labour relations, which have obstructed cost cutting, and by slow progress on technological advances that would give Korean autos an edge.
“Quality reviews and customer surveys have shown good progression, but Japanese rivals have been steadily cutting costs, so the premium on Japanese cars in European and US markets is no longer big enough to allow Korean manufacturers to increase margins or market share,” he says.
Better prospects
By contrast, he is more sanguine on the prospects for the largest players in the technology sector, at least in the medium term, thanks to their more flexible labour force and strong ownership of intellectual property.
“We are going through a process of separating the wheat from the chaff, with Korean companies that do not own enough of their technology caught by the vanguard of Chinese players. But Samsung in particular has developed most of its technology in-house, and has a strong brand name that enabled it to maintain a price premium on most products over the last cycle.”
Nevertheless, in the longer term, he sees Chinese companies today biting at the heels of Korean rivals in the same way that Korean companies took on Japan 20 years ago. “Essentially, it is going to come down to how fast Korean companies can change their production base and leverage China to keep up, but there are many that simply do not have the technological advantage to do this.”
High investment levels will be crucial to capture that technological advantage, but questions about corporate governance in the chaebol conglomerates persist, potentially deterring investors. Earlier this year, Hyundai Motor chairman Chung Mong-Koo was given a three-year suspended sentence for embezzling company funds, but Evans is phlegmatic about the overall picture: “I tend to categorize the situation as two steps forward, one step back.” He points out that before the Asia crisis in the 1990s, cross-holdings were so great that investors had no way of knowing where their money was going in the overall group, and transfer-pricing was rife.
“There is much better transparency on a group basis today, and investor relations are more polished, but Korea is still very much an emerging market in terms of overall business practices, with the sheer diversity of each chaebol naturally leading to opaque corporate structures.”