Weakness from Within in South Korea

(Export Development Canada – Peter G. Hall)

The story is getting all too familiar: yet another economy joining the ranks of those succumbing to the slowdown that began in the large economies. Scoping the reach of the slowdown has turned a lot of attention to bellwether trading economies in the Asia-Pacific zone. In this context, recent softening in South Korea shouldn’t be surprising – is it just a rerun of the unfolding global story?

Trade plays a huge role in the South Korean economy. Exports accounted for 61% of economy-wide output in 2007, a share that has swelled in recent years from just 24% in the mid-1990s. Imports are also a large share of activity, but South Korea’s real trade surplus has surged from a deficit position in the mid-1990s to a whopping 11% of economic output in 2007. The bulk of the surge occurred in the post-2002 period, when trade chipped in half of the economy’s total growth.

Such trade-dependence sounds like a prescription for a shake-up in today’s environment. But so far, South Korea is bucking the global trend in a big way. Real export growth has risen steadily since 2005, clocking 16% annualized growth in the April-June period. Monthly exports were up 37% in July compared with a year ago, in spite of much slower activity to the US and Eurozone markets. Surging shipments to top customer China, and also Japan, Southeast Asia and the GCC region, more than made up for the weaker destinations. In sum, export activity remains robust.

Even so, trade’s overall contribution seems to be faltering. Recent import growth has also accelerated, knocking South Korea’s nominal trade balance into deficit last December, where it remained in July. Normally an indication of potentially dangerous red-hot growth in the domestic economy, this turn of events is more about high commodity prices. As a large importer of commodities, South Korea’s import tab has taken a big bite out of the export bonanza.

Oddly, South Korea’s internal economy is where the key concern lies. Domestic demand slowed to a crawl in the second quarter as plunging consumer confidence halted spending activity abruptly. Moreover, difficulties in the housing market put the brakes on investment spending. Increased government outlays were not significant enough to offset weakness in the other categories. As such, in spite of the vigorous export picture, overall growth slowed to a 3.4% annualized pace in the second quarter, down from 5% in 2007.

The mix of growth is not comforting. It has become increasingly difficult for larger economies – particularly trade-dependent ones – to dodge the bullet of slowing global growth. While the spread of weakness has been more protracted than expected, it has been persistent. And the wave now seems to be hitting Japan, China and other key South Korean customers. With the bulk of pundits now expecting world economic problems to continue in 2009, hopes for a timely, rapid reversal of the current trend are fading. In this context, South Korean exporters will find it difficult to pass on rising input costs to customers, putting the squeeze on corporate profits.

The bottom line? The current source of South Korean weakness is surprising. With export activity soon likely to feel the effects of the softer global slowdown, and no domestic economy to fall back on, South Korea’s economy is highly vulnerable to a swift change in its fortunes.