Park Guen-hye became South Korea’s first female president in 2013 but also the first one to be successfully impeached after the constitutional court upheld a parliamentary motion to remove Ms. Park from office (in 2004, Roh Moo-hyun was also impeached but the court allowed him to return to office). Her main crime was to disclose and discuss state secrets with her confidante, Ms. Choi Soon-sil, whom she also helped to amass a small fortune by asking monetary favours from chaebols (corporate conglomerates) in exchange for targeted policies. One of alleged accomplices is Lee Jae-yong, Samsung’s leader in waiting, who is accused of paying bribes to Ms. Choi in exchange for government pension funds to vote for a merger of two Samsung affiliates in 2015, which strengthened the Lee family’s control over Samsung Electronics, the jewel in the crown of the Samsung chaebol. Ms. Park probably will face indictment and time in jail as she no longer benefits from immunity for criminal investigation.

Rocking from Blue House to Jailhouse…

The political crisis comes at a time when Korea is facing many challenges at once: its northern neigbour is experimenting with rockets with the aim to nuke Seoul; Korea’s economy is slowing down; and risks of a trade conflict have increased since Trump sits in the Oval Office.

Although Korea has world-beating companies like Samsung Electronics and Hyundai Motors and its economy has been one of the world’s fastest growing economies over the last decennia, there are a number of structural weaknesses that will hinder future growth. These weaknesses very much resemble those of Japan (it probably is considered an affront, but the Koreans are a copy of the Japanese). The Korean economy is export-driven, exports account for nearly 60% of demand, but global trade has slowed down since the financial crisis and competition has increased, notably from China. Productivity is low: productivity of highly efficient producers like Samsung Electronics is dragged down by moribund productivity in the service sector and in small enterprises. Furthermore, Korea is a highly unequal country with low labour force participation by females and elderly people (it is not unusual for a 50+ year old worker to get demoted or pushed out to make place for a younger worker with more skills), who also get paid less and get temporary jobs only. This is partly a cultural issue and is becoming a major problem as the population is aging (based on current projections, 70% of the population as percentage of working-age population will be aged 65 and over by 2050, comparable to Japan). Although Korean scientists already are able to clone dogs, we are not sure whether they can repeat this feat with humans anytime soon. Thus, the government should address productivity and labour force participation issues in particular.

Apart from structural weaknesses, Korea is also facing cyclical headwinds. The slowing demand from China, its largest trading partner, in the last couple of years had a big impact on Korean exports. Heavy industry got indirectly hit by the collapse in commodity prices, for example reducing demand for bulk carriers and oil drilling vessels, and directly by an increase in capacity in low-cost countries (e.g. steel in China and Russia). Domestic demand was stimulated by fiscal and monetary measures but household debt is sky-high (90% of GDP), dampening the room for an increase in consumer demand. Growth is expected to muddle through at 2.5-3.0% for 2017-2018 despite better trade and higher production in China (as illustrated by a PMI of 51.6 in February). Korea has ample room to support the economy with both a current account surplus and fiscal surplus (7.0% and 0.8% respectively in 2016) whereas gross public debt is at a manageable 40% of GDP. However, the government (of Ms. Park at least) is reluctant to ease and run up fiscal deficits to spur growth, possibly a remnant of a near-death experience during the Asian crisis in 1997 or in anticipation of the larger sums needed to support Korea’s accelerating share of elderly people in the future.

Psy for president…?

It is likely that the ruling Saenuri party of Ms. Park will lose the presidential elections that need to be held within 60 days (i.e. first half of May). Moon Jae-in, an admirer of Roh Moo-hyun and member of the centre-left Minjoo party, seems to be the frontrunner. Mr. Moon is a liberal (or communist to some) and wants to placate the Chinese by reconsidering the deployment of Thaad (a system developed by the U.S. to catch rockets launched from the North but the Chinese believe the system can be used against them as well). He also aims to re-establish economic ties with North Korea, possibly leading to unification (good luck with that…). Many of the leading candidates for the presidency, including Mr. Moon, favour breaking up the chaebols. Although there certainly are issues with these family-run conglomerates (shady governance being one of them), we believe it is not wise to undo them without proper consideration. In any case, one should not forget that these companies laid the foundation for Korea’s spectacular growth since the 1950s and most of them still are highly competitive in global markets. Chaebol reform should not be a priority, in our view, but something to be addressed at a later stage. Better to focus on restructuring (or closing) distressed companies and companies in sectors that struggle with overcapacity, as Ms. Park’s government has been doing, and address the structural weaknesses mentioned above (productivity, labour force participation and segmentation). A slowdown of economic growth in China combined with tighter global financial conditions (higher dollar interest rates and widening credit spreads) and possibly a Trump-inspired global trade war form a big risk to Korea’s economic health. The next government should rapidly implement policies to make the economy more resilient, Gangnam style…