Sunday, April 19, 2015

Korean workers’ tax burden not as bad as it seems

First published in The Korea Herald.

Going by the recent debates on tax hikes in Korea and President Park Geun-hye’s firm resolve not to place “an additional burden on the public,” it would appear that the Koreans are being taxed heavily.

Although it is true that economic growth is stagnant, and employment rates are not too rosy, a new report by the Organization of Economic Cooperation and Development has just shattered the myth that the tax burden in Korea is unusually high. 

The OECD report, Taxing Wages 2015, released on April 14, says the tax burden has increased in 23 member countries and fallen in 10 over the past five years. And guess which group Korea falls into?

That’s right, from 2010 to 2014, the tax burden in Korea has declined, even as the middle class in most other developed countries are feeling the heat.

The annual report provides unique information on the taxes paid on wages in OECD countries. It covers personal income taxes and social security contributions paid by employees; social security contributions and payroll taxes paid by employers and cash benefits paid by in-work families. 

The results enable quantitative cross-country comparisons of labor cost levels and the overall tax and benefit position of single people and families on different levels of income.

The tax and social security contribution burden is measured by the “tax wedge” ― or the percentage of employers’ labor costs taken up by taxes, minus family benefits.

Because labor is an important economic input, higher employment rates will lead to higher GDP, other things being equal. 

Yet employment has declined markedly in Korea over the past few years. These poor employment outcomes are often blamed on high taxes on labor, since taxes discourage both demand and supply, by raising labor costs for employers and lowering workers’ effective wages.

This creates a “tax wedge” between labor costs to the employer and the worker’s take-home pay.

The tax wedge, measured as a percentage of taxes and transfers paid in the share of total labor costs, is therefore a measure of the overall level of workers’ taxation.

Now let us see what the analysis of Korea states.

According to the report, Korea has the fifth-lowest tax wedge among the 34 OECD member countries. The average single worker in Korea faced a tax wedge of 21.5 percent in 2014, compared with the OECD average of 36 percent.

In Korea, employee and employer social security contributions combine to account for 79 percent of the total tax wedge, compared with 63 percent of the total OECD average tax wedge.

The tax wedge for a worker with children may be lower than for a worker on the same income without children, since many OECD countries provide benefits to families with children through cash transfers and preferential tax provisions. Korea has the eighth-lowest tax wedge in the OECD for an average married worker with two children, at 19 percent, which compares with the OECD average of 26.9 percent.

Child-related benefits and tax provisions tend to reduce the tax wedge for workers with children compared with the average single worker. In Korea in 2014, this reduction ― 2.5 percentage points ― was less than for the OECD average of 9.1 percentage points.

Looking at the trend over a long period, the OECD report states that since 2009, the tax wedge for the average single worker increased by 2 percentage points in Korea. During this same period, the tax wedge for the average single worker across the OECD increased by 0.9 percentage points. In other words, while it is true that single workers without children in Korea have felt the pain of taxes most, it is not as bad as it is made out to be.

The employee net tax burden is a measure of the net tax burden on labor income borne directly by the employee. Korea had the third-lowest employee net tax burden for an average single worker at 13.4 percent in 2014, compared with the OECD average of 25.5 percent. That is, in Korea the take-home pay of an average single worker, after tax and benefits, was 86.6 percent of their gross wage.

Taking into account child-related benefits and tax provisions, the employee net tax burden for an average married worker with two children in Korea was reduced to 10.7 percent in 2014, compared with 14.8 percent for the OECD average. Which means that an average married worker with two children in Korea had a take-home pay, after tax and family benefits, of 89.3 percent of their gross wage, compared to 85.2 percent for the OECD average.

The key takeaways from this analysis is that the tax system in Korea is becoming more progressive for low-income households, especially households with children. This is obvious from the fact that the tax wedge for families with children is lower than that for single individuals without children.

Also, an increase in the tax wedge leads to an increase in companies’ labor costs. However, in Korea, there has been a decline. So clearly the corporate sector, which has been tight-fisted in raising salaries or hiring needs a rethink. It is therefore a good thing that the government is imposing additional taxes on companies who do not make use of their cash reserves.

Lastly, there is no reason why the government should be so adamant about not raising taxes. Policymakers should look beyond short-term election outcomes and concentrate on the longer-term impact of raising taxes for certain people.

Saturday, April 11, 2015

Labor reforms face hurdles in Korea

First published in The Korea Herald.

The presidential office last week urged representatives of labor, management and the government to compromise on contentious reform measures aimed at providing greater flexibility in the labor market, a day after they failed to narrow their differences within the deadline.

The Economic and Social Development Commission ― a consultative body comprising representatives of labor, management and the government ― had set March 31 as the deadline for concluding months of talks on overhauling Korea’s labor market.

The discussions focused on the issue of the labor market’s dual structure ― the huge gap between full-time regular employees and nonregular workers ― pending topics like wages, working hours and retirement, the issue of partnership among tripartite partners, and other policy and institutional improvements.

In particular, in light of the importance and urgency of the pending issues such as the reduction of working hours and ordinary wages ― whether to include regularly-paid bonuses in ordinary wage calculations ― they agreed to come up with “principles and direction for a solution of the pending issues and labor market structure improvement.” Details are expected to be arranged in the first half of the year.

The trilateral meetings reportedly reached some agreement, especially on ordinary wages, plans to reduce working hours and an extension of the retirement age. However, labor unions strongly resisted a government proposal to grant employers more discretion in firing underperforming regular workers. News reports also suggested that management opposed the labor groups’ suggestion to force them to give nonregular workers regular status if their work is similar to that of regular workers.

The presidential office took the unusual step of reminding the panel to find common ground, stressing “it is necessary for the nation’s economic growth and future generations.”

The overhaul of the labor market is one of the reform measures President Park Gyeun-hye is pushing as part of her three-year economic revitalization plan. She has argued that labor reform is key to job creation.

To increase labor market flexibility, the government and management have urged labor groups to accept the idea of lifting some labor regulations for employers so they can replace underperforming workers. But labor groups oppose the idea, saying it would eventually allow businesses to seek massive lay-offs and pressure poorly performing workers to accept salary reductions.

The idea is intended to force regular workers out and replace them with nonregular workers, which would lower the overall quality of jobs, they claim.

Given the continued mistrust between the concerned parties, it is unlikely that they will reach an agreement anytime soon. Unions have even threatened a general strike if the government and management push for reforms without consent from workers.

Therefore it may be prudent to take a look at Korea’s labor market from a historical perspective, before we analyze what, exactly, are some of the current problems.

Seeing eye-to-eye

Since the 1960s, Korea has achieved remarkable economic growth, mainly due to cheap labor and diligent and skilled workers. Labor policies during this period were intended to guarantee the basic livelihood of workers and provide sufficient workers for industrial development. But it was not until the mid-1970s that the government recognized the importance of labor issues.

Until then, industrial relations were not viewed as a major social and economic issue, but in the following years, when the country’s labor market saturated, the problem of working conditions replaced that of job creation as the central social and economic focus. Many fierce labor disputes erupted, which resulted in severe government crackdowns.

In the early 1980s, workers’ awareness of their rights became widespread, especially with regard to claiming their fair share of the fruits of the economic growth achieved in the past two decades. However, the government cracked down on the labor movement. As a result, in spite of the marked increase in the number of workers from 1980 to 1987 and the growing awareness of their rights, the number of unionized workers remained at around 1 million.

With rapid democratization in 1987, Korea underwent significant changes in its labor movement. A number of new labor unions were formed, and many businesses saw a dramatic increase in disputes.

The shortage of manual workers in the construction and manufacturing sectors became acute as workers became less willing to take on difficult, dirty and dangerous jobs.

Labor was no longer cheap, as wages rapidly increased. These changes forced the nation to transform from a labor-intensive economy a more technology-based one.

The labor policy underwent dramatic changes through the reduction of government intervention based on the principle of labor-management autonomy and the revision of labor-related laws to meet international standards.

The government also made efforts to actively promote the interests of workers with the institutionalization of the minimum wage system, the reduction of working hours and the abolition of legal restrictions on strikes.

Trade unions called for the introduction of new labor laws in the early 1990s to ensure that job seekers received appropriate vocational training to meet the demand for new skills generated by structural changes in companies. When the nation was hit by the 1997 Asian financial crisis, the urgent need to reform both the social and economic sectors was recognized.

While making continuous efforts to reach a consensus on major labor issues, the government revised labor laws to meet international standards in 1997 with the founding of the Labor-Management Relations Reform Committee, thereby achieving remarkable improvements in the area of basic labor rights. However, it had its own side effects.

The Tripartite Commission was formed as the need to draw a national consensus for the sake of overcoming the economic crisis became clear after Korea had to introduce reforms after being bailed out by the International Monetary Fund. A historic consensus was reached among labor, management and the government over structural reforms and burden-sharing in February 1998. On the basis of this consensus, many businesses could implement corporate restructuring measures, including employment adjustments and pay freezes.

Since 2000, there have been both legislative reforms such as shortening working hours, enacting the Law on Nonregular Works, and structural reforms such as the spread of industry-level unions and the expansion of labor’s political activities.

Thanks to such efforts, the economy rebounded quickly. Industrial relations, however, worsened as expectations ran high and more structural reforms got underway. The number of factors that contributed to labor-management conflicts, such as lay-offs, a decrease in new hiring, a larger number of nonregular workers, a widening gap between labor and management positions on wage hikes, compensation and provisional seizure claims against strikers etc., has been on the rise, in line with worsening economic conditions.

Experts have pointed out that despite this, when comparing Korea’s labor standards and regulations to those of advanced economies, it is important to keep in mind that the core labor standards have developed through an evolutionary process over more than a century, and it has been less than 30 years since the democratic movement in 1987 began to free Korea from its long past of oppression and autocratic control. It can be safely said that Korea’s labor movement is still in a transitional period, in which the labor structure is slowly converging with global labor culture and practices.

Trade unions

Trade unions in Korea are broadly divided into three organizational types: enterprise-level trade unions, federations of trade unions and nationwide federations of trade unions. There are 42 federations of enterprise-level unions and two nationwide federations.

The Federation of Korean Trade Unions was formed in 1961 after a military coup, and the dissolution of the General Federation of Korean Trade Unions and its affiliates. It was placed under the guidance of the military authorities and was the sole legal trade union center in Korea until the Korean Confederation of Trade Unions was recognized in November 1999. Of the two, the KCTU is generally considered to be more militant.

As of the end of 2013 ― the latest available government estimates ― the number of unionized workers in Korea was 1.848 million, up 66,000 from the previous year. The unionization rate was 10.3 percent, meaning that 1 in 10 Korean workers is a member of a trade union.

According to a report on trade unions published by the Ministry of Employment and Labor, Korea’s unionization rate fell from 19.8 percent in 1989, and declined to single digits (9.8 percent) for the first time in 2010. In 2011, the figure bounced back to 10.1 percent, due to the law allowing multiple unions to operate within one company, and has stayed around 10.3 percent for the past few years.

Segmenting the number of unionized workers by umbrella organizations shows that the FKTU had the largest membership of 819,755 members (44.4 percent); the KCTU had 626,035 members (20.7 percent); the Korean Labor Unions Confederation had 22,221 members (1.1 percent); and the remaining 381,575 workers (20.7 percent) belonged to independent trade unions.

The number of members climbed by 11,000 (1.4 percent) for the FKTU; by 21,000 (3.5 percent) for the KCTU; by 2,000 (12.9 percent) for the KLUC; and by 32,000 (9 percent) for independent unions.

At end-December 2014, it was announced that the FKTU and the KLUC would merge. They claimed that the decision to reconstitute as a single organization was “to eliminate unnecessary conflict between labor organizations, make themselves more reliable for the public, and play a bigger role in social issues based on a higher unionization rate.”

As a result of the merger, the FKTU will take on 15,000 government workers belonging to the KLUC to reach 960,000 members.

The number of independent unions, meanwhile, went up eightfold, compared with 2003, perhaps due to a new tendency emerging among workers to pursue practical interests, instead of politically-charged labor movements, the report noted.

According to sectorial classification, private sector labor unionization is 9.1 percent, the government employee unionization rate is 63.5 percent, and the educational worker unionization rate is 16.8 percent.

It is important to mention that the ESDC has been seriously disrupted by the KCTU’s struggles against the government and the withdrawal of the FKTU. However, in mid-August 2014, the FKTU returned to the ESDC and the urgent labor issues of ordinary wages, working hour reductions and the retirement age are currently under discussion.

Labor relations

As per the latest available figures, in 2014 there were over 100 labor disputes and 551,305 lost working days. Given the stalemate in the ESDC talks, one can only expect the conflict between labor and management to degenerate this year.

For that matter, according to a recent survey of 306 companies by the Korea Employer’s Federation, 63.1 percent of respondents said “industrial relations will worsen in 2015 than last year.” Being more specific, 11.4 percent of companies responded that “industrial relations will worsen much,” “industrial relations will worsen a little” (51.7 percent), “similar to last year” (33.5 percent), and “more stable” (3.4 percent).

The most common answer from companies was “industrial relations will worsen” due to conflicts surrounding industrial relations regarding ordinary wages, the reduction of working hours, and in-house subcontracts and partner firms (outsourcing).

The major risk factor in industrial relations in 2015 are legal conflicts surrounding pending industrial relations issues, conflicts over the improvement of the wage system, and the improvement of labor related law and systems.

The companies which projected unstable industrial relations in 2015 pointed out legal conflicts surrounding pending industrial relations issues, conflicts over the improvement of the wage system, and the improvement of labor-related law, and systems. In particular, companies viewed the expansion of legal conflicts surrounding pending industrial relations issues as the biggest risk factor since the burden on companies increased due to lawsuits regarding ordinary wages on industrial sites, ruling on additional payments for holiday work, and ruling on the violation of illegal dispatches.

Companies projected that the major issues in the 2015 wage negotiation and collective bargaining would be wage increases, extended scope of ordinary wages, welfare expansion and employment security like prohibiting reconstruction. In particular, it is presumed that many companies would carry out only wage negotiations and trade unions would focus on demanding wage hikes and welfare expansion that are the major interests of union members.

Moreover, the government announced its Comprehensive Measures for Nonregular Workers in 2014, stating its intention to work on structural reform of the labor market ― enhancing flexibility within the labor market and reforming wage systems.

Furthermore, discussions on changes to labor law and regulations will not be easy since labor is strongly opposed to the government’s policies in this area. Conflict between the government and labor may well intensify as the government plans structural adjustments to public institutions and public pensions. Under these circumstances, collective bargaining this year is likely to be difficult.

Issues on hand

On Dec. 29, the government submitted comprehensive plans for nonregular workers to the ESDC aimed at eliminating the abuse of and discrimination against nonregular workers, and narrowing the gap in terms of working conditions between regular and nonregular workers.

To achieve these goals, the plans focus on reducing the differences between workers of different status, enhancing job security, and improving regulations for the labor market.

As of end-2014, the number of nonregular workers was about 32.4 percent of the total paid workforce, a 53.5 percent of female workers. The percentage of nonregular workers among workers aged 60 or older was 68.7 percent.

The government has proposed a measure to amend the fixed-term work act and the temporary agency work act so that employees of either status aged 35 years or older can, if they want, work for the same company for up to four years, as opposed to the current two. Also, it would become much easier for workers to be eligible for severance pay. It wants to make employees eligible to receive severance pay if they work for a company for three months or longer, as opposed to the current one year or longer, so 1.95 million workers are expected to benefit from this relaxation in requirements.

In addition, the government recommended that employees should be able to receive a transition benefit worth 10 percent of their wage for the two-year period of extended service, along with severance pay if they fail to become regular workers after the extension.

So far, temporary agency work has been permitted in 32 business categories, and such work is now allowed for those aged 55 years or older, and for highly paid professionals as well.

The Labor Ministry said it would take measures to rationalize the regulations on temporary agency work following discussions with the ESDC. The ministry will also allow six special types of worker to be covered by work injury and employment insurance.

The requirements for layoffs will become more specific, making it easier for businesses to dismiss underperforming regular workers, and the layoff process will become more demanding, requiring companies to hire people for positions that were lost due to financial difficulties.

The government will formulate “Layoff Guidelines,” which will specify what efforts companies should make before dismissing underperformers, such as assigning them to different positions.

Currently, nonregular workers have to appeal to the Labor Relations Commission as individuals if they believe they have been discriminated against in terms of wages or welfare benefits, but they will be able to use a trade union to appeal on their behalf. Businesses will be prohibited from the practice of paying only 90 percent of the full salary for menial workers, such as convenience store clerks or gas station workers, for a training period, which is usually three months.

Also, for those whose performance is closely linked to human safety, such as captains or chief engineers on cruisers, train engineers, airport controllers and airplane pilots, nonregular work will not be allowed as a matter of principle.

However, both business and labor communities have expressed their concerns about the “side effects” of the government plans.

The corporate sector has argued that “The government plans will expand the scope of nonregular workers too much, and have focused on strengthening regulations relating to the use of nonregular workers, ignoring the real situations of employers and of the labor market. The plans will put significant burdens on business operations.”

In an official statement, the KEF noted that the reforms “disregarded the circumstances of corporates that are the main agents for job creation and the reality of the labor market. It is deeply concerning that these opinions are written in a way that it mainly represents the labor stance on important issues that possibly influence decisions on directions for the Korean labor market.”

The barriers to labor market entry should be lowered in order to create jobs and improve the dual structure of the labor market, it said. However, the current policy will “strengthen the vested rights of workers who are already in the labor market.”

Major causes for polarization of the labor market are the overprotection of regular employment and the excessive hike of wages based on a seniority-based wage system. Therefore, it is almost impossible to expect an improvement of vulnerable workers’ labor conditions unless these issues are solved in the first place.

However, these new regulations may shift the burden to companies by disregarding the improvement of reasonable human resource management such as resolving the current overprotection of regular employment and alleviating requirements for changing working conditions.

Also, it is not appropriate to intensify the burden through introducing such systems as living wages and market wage prices at a time when minimum wage stability is urgent, since minimum wages surged rapidly after 2000.

Trade unions point out that “The government is seeking to massively increase the number of nonregular workers by extending how long companies can hire a nonregular worker for a position, by introducing a new status of ‘semiregular worker,’ which falls between regular and nonregular workers, and by allowing temporary agency workers aged 55 years or older in more business categories.”

Kim Dong-man, president of the FKTU, which is negotiating in the trilateral commission, stressed, “The government is pushing ahead with full-scale strategies for labor flexibility without making an effort to reach an agreement among social partners. We have no option but to stop social dialogue if the government continues to do so. The unilateral plan will be faced with strong protest by the FKTU and we are ready to stage a general strike.”

He went on to say, “We are demanding the government drastically change the economic structure and policy directions for the achievement of income-led growth. To this end, we will step up our efforts for the alleviation of discrimination against precarious workers, the eradication of unfair subcontracting practices and the achievement of fair taxation.”

It now remains to be seen whether the government can get labor groups and management on the same page in the near future, so the Park administration can focus on economic revitalization. The next few weeks are surely going to be very dramatic.

Tuesday, April 7, 2015

E-commerce opportunities surging in Korea

First published in The Korea Herald.

E-commerce is rapidly transforming the way in which enterprises are interacting with each other, as well as with consumers, and growing rapidly across the globe. Korea is no exception and it has clocked rapid growth in recent years.

According to Statistics Korea, in the business-to-consumer, or B2C segment, the online shopping transaction value reached 45.24 trillion won ($41.02 billion) in 2014, which increased 17.5 percent from 38.50 trillion won in 2013. The mobile shopping transaction value recorded 14.81 trillion won in 2014, which increased 125.8 percent from 2013.

Furthermore, in a recent report that has been overlooked by local media, the United Nations Conference on Trade and Development has many positive things to say about Korea’s e-commerce industry.

The 125-page Information Economy Report 2015, released on March 24, examines the potential opportunities and risks of e-commerce and examines how countries can benefit the most from the phenomenon in today’s information society.

More importantly, it has also compiled the first B2C E-commerce Index, which will be updated annually, and can serve as a useful tool for countries wishing to assess their readiness to engage successfully in online commerce.

This index is significant because until now, there were few benchmarks of country e-commerce performance. Those that exist suffer from a lack of public availability, scope or consistent methodology, as well as limited geographical coverage.

The UNCTAD Index ― which compares affordable Internet access, mechanisms for paying for goods and services ordered online, and effective solutions for their delivery ― allows countries not only to compare their performance against others, but also indicates where they are relatively strong and where there may be a need for improvement.

In what should please our policymakers, Korea is placed positively in the index with a rank of 8 among 130 countries with a score of 84.3. The countries ahead of Korea include Luxembourg (91.7), Norway (88.3), Finland (88.1), Canada (87.1), Sweden (86), Australia (85.5) and Denmark (84.7).

Noticeably, Korea is way ahead of its Asian counterparts, with Hong Kong ranking 18 and Singapore 26.

The report also looks at rural e-commerce by showcasing the case of Korea. As it notes, the experience in Korea is positive, with rural e-commerce sales continually rising. Success factors include close collaboration between the government, operators and rural citizens to market and sell goods and services.

While the report may appear favorable to Korea, one should bear in mind there is one crucial aspect that has not been included in the Index ― legal and regulatory framework ― which influences the degree of trust in online transactions.

This issue is all the more important, given that the e-commerce market in Korea is booming.

Having said that, one must compliment the Korean government for this performance. With typical Korean farsightedness, e-commerce has figured in the government’s thinking since the late ’90s.

In 1999 the Korean government ― among the first to do so worldwide ― established the “Basic Act on Electronic Commerce,” which was followed by the “Comprehensive Policies for e-Commerce” in 2000 and “e-Business Initiative in Korea” in 2001.

The government’s stated aim was to play an active role in the globalization of e-business and fully promote it as a means to realize structural innovation of its industry and strengthen the competitiveness of Korean companies.

However in the process, attention was being paid to only one segment of e-commerce ― B2C transactions.

When we talk about e-commerce the first thing that pops into our mind is B2C. It involves sales by e-commerce enterprises to consumers and online sales channels of bricks-and-mortar retail outlets or manufacturing firms.

What is not given as much attention is the business-to-business, or B2B commerce. This actually accounts for the bulk of e-commerce worldwide.

It involves transactions between businesses, such as between a manufacturer and a wholesaler, or between a wholesaler and a retailer.

Then there is consumer-to-consumer commerce, or C2C, which covers online action platforms and sales within online communities. This is followed by business-to-government commerce, or B2G, where the buyer is the government entity, such as in the case of public e-procurement.

While B2C has shown remarkable growth, development of the B2B and B2G sectors have not kept pace.

Unfortunately, Statistics Korea stopped collating statistics on B2B and B2G transactions from the first quarter of 2014, so there are no numbers to compare and evaluate. It had argued that “based on the opinions from policymaking agencies, research institutes and universities, we concluded that e-commerce statistics were not any longer useful.”

In recent months there has been steady news of the conglomerates jumping on the B2B bandwagon and investing more resources, seeing the huge potential. This is surely driving the e-commerce market in Korea.

However, for small and medium enterprises, it is a totally different ballgame. Many studies suggest that B2B offers greater potential benefits for smaller business than other forms of e-commerce. Although they need to engage in B2B e-commerce to participate in national or global value chains, they have not been able to take full advantage.

The e-commerce utilization in SMEs is currently found to be quite insufficient. While there are no regulatory hurdles, clearly the initial cost of setting up a B2B system is too high for them.

The government, for its part, is doing its bit by promoting various projects, such as creating infrastructure by establishing and standardizing B2B networks in industries, developing technology, and fostering manpower.

For years e-commerce has been directed at B2C businesses. Now, however, after substantial shifts in buyer behavior, the industry is changing. E-commerce is becoming a leveled playing field between B2C and B2B.

This is presenting some immense opportunities for B2B businesses and making way for a new age of hybrid companies, and the government should proactively help Korean SMEs jump on the bandwagon, instead of sitting by and watching conglomerates take away the entire market.

It should launch projects on international cooperation for the global B2B market so that SMEs can expand their business. Policies should also constantly be identified to keep up with new changes in the market.

Additionally, Statistics Korea should resume publishing regular data on B2B and B2G transactions. It will help the government in tracking developments and tweaking policy when needed.

Sunday, March 29, 2015

Deregulate lotteries to fund welfare

First published in The Korea Herald.

There has been a heated debate in recent months about the need to raise taxes in Korea to generate revenue for the various government welfare programs to support the needy. While President Park Geun-hye has ruled out the possibility of raising taxes and is instead eyeing the “shadow economy” to get the much-needed funds, there is one other source that has been completely overlooked ― lotteries.

Lotteries are of particular interest to public finance economists since they represent an important source of government revenue in many countries. As a significant contributor to the government kitty, they have been widely examined by economists focusing primarily on their revenue potential and desirability as a method of taxation ― in many countries they exceed in magnitude tax collections on goods such as alcohol or tobacco.

Moreover, lotteries run for or by governments are used to support public programs such as infrastructure development, public safety, public health and education. The principal argument used to support lotteries has focused on their value as a source of “harmless” revenue, contributed by players voluntarily spending their money.

Critics have, of course, argued that lotteries for the most part have a regressive impact ― in the sense that the burden falls disproportionately on people with lower incomes, who typically spend a greater portion of their income on lotteries than those with higher incomes.

That said, while the lottery market in Korea has been growing, the pace of growth has been very negligible. Moreover, the lottery options available to customers are also limited.

Korea’s lottery business model currently has a three-tier structure: the Korea Lottery Commission, primary lottery operators and secondary lottery operators.

The KLC, a government agency responsible for formulating and implementing lottery-related policies, has exclusive authority to issue, sell and manage lottery products, but it entrusts private lottery companies with the operations.

The available lottery schemes are: online lottery game Lotto 6/45, four printed lottery games ― one draw game, three instant games ― and seven Internet lottery games ― four draw games, three instant games. Then there is a sports lottery.

Unlike in other countries, the National Gambling Control Commission, a regulator under the Prime Minister’s Office, sets a limit on sales each year for the industry as part of its efforts “to control, supervise and regulate the gambling industry independently, with prevention policies as the first priority.”

The Finance Ministry asks the NGCC every year to eliminate the sales ceiling, arguing that the lottery is less addictive than other gambling industries and its share of GDP is half of the OECD average and one-third of the rate in other Asian countries. The NGCC has consistently refused the request, afraid of annoying the antigambling lobby.

Since lottery tickets went on sale for the first time in 1947, printed lottery tickets have been dominant in Korea. But from 2003, the Korean lottery market has become disproportionately lopsided toward the online lottery.

Industry experts have noted that Koreans want to try out new lottery products, but the limited options and lack of enthusiasm for other products that offer lesser payouts made them switch back to Lotto.

Lotto continues to offer the highest prize money among all available lotteries, but it is just a fraction of that in other developed markets. While jackpots often run into hundreds of millions of dollars in Europe and the U.S., the average single jackpot prize in Korea works out to around $2 million.

The growth of this industry is artificially restricted as the government has been under constant pressure to “stabilize the market and curb reckless gambling.” On the contrary, by artificially constraining the legal lottery market, the government helps sustain the growth of illegal gambling.

The latest statistics of the Finance Ministry show that Korea’s lottery industry grew for the ninth year in a row in 2014, with total sales surpassing 19.87 trillion won.

According to official data, gambling-related sales ― casinos, lotteries, horse, cycling and boat races and traditional bullfights ― grew 1 percent, by 199.2 billion won from the year before. For 2015, government officials expect the size of the industry will top 20 trillion won, mainly from a rise in demand for lotteries and casinos.

Of this, sales of various lottery tickets and sports betting exceeded 3.28 trillion won each, up 1.4 percent and 6.5 percent, from the year before.

The NGCC’s claim that the domestic lottery market is overheating is far from true. It has only been showing modest growth.

If we contrast the performance of Korean lottery sales with average performances in the Asia-Pacific, the real picture emerges. Estimates by the World Lottery Association show that Asia-Pacific lotteries have been witnessing average growth of over 10 percent.

The fastest-growing market is China. According to government figures, China’s lottery market continued to grow in 2014, with total lottery sales of $61.2 billion, representing a growth of 23.6 percent.

Even in European countries smaller than Korea, with historically similar income levels, the lottery market is almost four times larger.

Clearly, the market growth in South Korea is insignificant given its potential.

It may be true that in the past the industry’s growth potential was limited because of the social stigma attached to lotteries in a Confucian society, but that restraint has slowly faded over the years.

If the lottery market is to expand, the legal and regulatory framework needs drastic changes. The operators should be allowed a wide portfolio of games, which they should be able to offer across all channels ― retail, Internet and mobile.

More importantly, if the government is serious about mopping up revenues without higher taxes, it should consider the lottery option for funding welfare schemes.

Currently, 35 percent of lottery proceeds are appropriated to 10 legally mandated projects in accordance with Article 56 of the Lottery and Lottery Fund Act; the remaining money is used to help low-income families with housing, veterans’ welfare, cultural heritage and art promotion, and other public works.

Instead of imposing penalties and curbing the growth of the market, the NGCC should do away with any limits and let the markets decide. It will go a long way in boosting the lottery market and help the government efforts to boost welfare without tax hikes.

Thursday, March 12, 2015

Dynamics of Korea-China economic relations

First published in The Korea Herald.

The much-awaited Korea-China Free Trade Agreement was initialed in late February, taking a step closer to implementing what is seen as Korea’s most significant trade deal.

The initialing came about three months after the two countries concluded FTA negotiations that began in May 2012, and is expected to eclipse its deals with the U.S. and the EU, as China is already its largest trading partner.

China, the world’s largest destination for Korean goods, accounted for more than one-quarter ― $145.28 billion ― of Korea’s overall exports of $572.66 billion in 2014. The next biggest national-level markets for Korean exporters are the United States at 11 percent and Japan at 6 percent.

According to news reports, the agreement, currently written in English, will be translated into the two countries’ native languages before it is officially signed.

“The two governments have agreed to work toward the official signing of the FTA within the first half of 2015,” the Ministry of Trade, Industry and Energy said in a press release.

The pact requires approval from both the respective legislatures for implementation, and will come into force immediately after it is passed.

Under the deal, Korea will completely eliminate its tariffs on 79 percent of all products, or 9,690 items, imported from China within 10 years of its implementation. China will reciprocate the move on 71 percent of the products, or 5,846 items, from Korea during the same period.

Within 20 years, Korea will eliminate its tariffs on 92 percent of all goods, with China eliminating its own import duties on 91 percent of products from Korea.

“The government will do its utmost to have the agreement ratified by the National Assembly without any disruption so that our companies can start benefiting from the Korea-China FTA at an early date,” the Trade Ministry said.

Soon after initialing the deal, Deputy Trade Minister Woo Tae-hee pointed out that some new and positive elements had been added to the agreement since the conclusion of negotiations on Nov. 10.

According to the government, 310 products from the inter-Korean joint industrial complex in Gaeseong will immediately benefit from a reduction or elimination of Chinese import tariffs.

The two countries have also added a new standstill clause in their bilateral agreement that will prevent either side from raising or adopting new customs duties on any products or services.

Through additional dialogue, Korea has gained better market access and established a better business environment in China for financial and communications service providers, the Trade Ministry said.

The two countries have also agreed to provide preferential treatment to each other’s financial firms and to set up a new committee to jointly deal with any business problems for the firms. They also guarantee nondiscriminatory access to communications networks by companies entering each other’s markets.

In addition, the Korean government moved to quieten fears of damage to its farmers, as 596 out of 2,240 agricultural and fisheries products currently imported from China will be permanently excluded from market liberalization, while 16 others, including rice, were excluded from negotiations from the beginning.

Following its implementation, the FTA is expected to help boost the countries’ annual bilateral trade to over $300 billion, a 21.54 percent hike from $235.36 billion in 2014.

Also, according to the government, Korea’s trade territory, represented by the combined gross domestic product of countries with which it has a free trade pact, will grow to 73 percent of global GDP from the current 61 percent.

There is no doubt that this a very significant deal and could have a very great impact on the economies of both countries.

However, as many analysts have pointed out, China’s rise puts Korea in a strategic dilemma between the U.S. and China. Traditionally, Korea and the U.S. have been close allies. Their alliance has been a major factor in Korea’s political and economic success. Due to China’s consistent rise, market growth and size, it so happens that Korea is now increasingly dependent on its neighbor’s economy. Consequently, it has to dually manage its security, which is grounded in the alliance with the U.S., and its economic well-being, which depends on its economic partnership with China.

It is therefore important to check how the economic relations panned out prior to the implementation of the FTA.

Economic relations

China established trade relations with Korea as early as the mid-1970s. However, due to the lack of formal diplomatic relations, most of the trade was conducted indirectly via Hong Kong, thus limiting trade volume.

Experts have suggested that their economic cooperation developed through three stages. In the early 1990s, many Korean politicians were eager to construct a dialogue with key political leaders of China. Business executives of Korean conglomerates then joined the politicians in opening channels for dialogue with China. Finally, in August 1992, a diplomatic relationship was established between both sides which opened a new chapter for bilateral economic relations.

The first stage started with diplomatic normalization and the beginning of the first China boom ― both trade and investment increased sharply from almost nothing. This trend continued until the second half of 1997, when the country was hit by the Asian financial crisis. Following this, the second stage brought about a slowdown bilateral economic relations, including the pulling out or canceling of many investment projects in China because of difficulties with Korean companies’ cash flow.

This did not last too long, however, since China became a member of the World Trade Organization in late 2001, which once again saw foreign companies flocking to the country, and Korea was no exception. Since then, China once again has been the biggest economic partner of Korea, including the development of a new destination of informal migration. As a consequence, it did not take long for the relationship to solidify, and in 2004, China became the exporting and investing country of first importance to Korea.

In the meantime, the trade structure has also changed considerably. In the early 1990s, trade from China to Korea was often in primary goods, as well as labor-intensive products, while China imported technology-intensive and capital-intensive manufactured products from Korea. In recent years, trade between the two countries is mostly in technology- and capital-intensive goods. Foreign-invested enterprises, especially those with investment from Korea, played a critical role in the structural changes of the bilateral trade.

As noted by Cheong Young-rok, professor at the Graduate School of International Studies at Seoul National University, “There are two different schools of thought in Korean academia: One school argues that China is a mere clone or extension of other Asian countries that were once glorified as newly industrializing economies or high-performing Asian economies. In this context, China could be a really tough competitor for Korean companies, especially for Korea’s exporting industries, and could undermine the export basis of Korean growth.

“The other school of thought tries to prove that China’s growth is intrinsic in the sense that it has resulted from a combination of improved resource allocation and a new model for a sizable economy that has been carried out by China’s own design. As a result, Koreans hope that China will become an additional country for quick economic interaction.”

The flip side of this increasingly tight economic relationship is, first, that Korea is now more dependent on the fate of the Chinese economy, and second that the risk of friction is higher than in the past.

Any fluctuation in the fortunes of the Chinese economy has an immediate impact on the Korean economy. If there is a slowdown in China, Korea’s trade is hurt badly, which has a ripple effect on other sectors.

Trade figures

If we look at the bilateral trade figures between both the countries in 2014, a number of important facts emerge.

According to latest available trade figures, Korea’s total exports to China in 2014 slipped by 0.4 percent on-year. The slowdown started in May 2014 when there was zero growth, and since then the monthly exports have registered consecutive negative growth. This was the first decline in five years.

This is significant, given that Korea relies heavily on its neighbor.

If we look at the export components, the picture becomes clearer. Korea’s exports to China are mostly comprised of intermediate and capital goods.

At the disaggregate level, in 2013, Korean exports to China were dominated by machinery and transport equipment (48 percent), followed by manufactured goods (24 percent), chemicals and related products (19.5 percent), and minerals, fuels and lubricants (6 percent). Crude materials, food and live animals, beverages and tobacco, commodities transactions, and animal and vegetable oils make up for the remainder of exports.

Now, if we look at the growth rate of these categories, something interesting emerges.

Export of machinery and transport equipment grew 4.6 percent on-year (from $70.49 billion to $73.72 billion) in 2014. This does seem positive, but if we look closer, the pace of growth has actually fallen drastically. In 2013, growth was at 21.8 percent. Since this group accounts for almost half of total exports, it is worrisome.

Next, the export of manufactured goods to China shows a negative growth of 5.4 percent, down to $22.82 billion. Chemicals and related products were down 4.2 percent at $27.14 billion; minerals, fuels and lubricants down by 12.5 percent; crude materials, food and live animals, commodities transactions, animal and vegetable oils all declined, by 6.6 percent, 1.6 percent, 39.6 percent and 43.3 percent, respectively.

Some explanations can be provided for this decline in South Korean exports to China.

Many news reports and studies have noted that Chinese manufacturers are now increasingly producing the parts and equipment that once were imported from Korea. However, many Korean companies still continue to regard China as a production base for exports to other countries. This is a fallacy because Chinese companies have fast developed their consumer goods market and are increasingly becoming self-sufficient in intermediary goods.

If, as has been the norm, Korea continues to export to China mostly products that are actually being exported to a third country, they will be in trouble if China’s exports falter.

Also hurting Korean exports is China’s growing self-sufficiency, with greater investment and technological abilities in industries where Korean companies have historically supplied exports.

As noted in many news reports, officials at the Trade Ministry agree and attribute this decline to the fact that China is improving its own supply capacity and therefore has reduced dependence on Korean intermediary goods. Chinese firms have started producing more of the intermediary goods on their own.

Local Chinese companies appear to be giving tough competition to Korean firms.

This is a view also taken by the state-funded think tank Korea Institute for International Economic Policy, which noted recently that China has been ramping up its own production capacity for intermediary goods and has less demand of its own for finished products because of moderating economic growth.

Hopefully, the FTA will set things right for Korea on the trade front. For this, the government needs to undertake a more detailed analysis to understand the cause for this decline and how Korean companies can overcome the situation.

Investment situation

Another important form of interaction between the two economies is foreign direct investment. FDI into China tends to be dominated by Asian investors, and Korea plays an increasing role in this respect.

In 2014, Korean companies’ investment in China ― financial sectors such as banking, securities, insurance were excluded ― hit an eight-year high last year and entered the $60 billion zone. By contrast, Japan’s investment in China dramatically decreased during the same period.

Recently, the Korea International Trade Association announced that the real investment of Korean companies in China in 2014 was $3.97 billion, which was 29.7 percent higher than that of the previous year. This is the highest in eight years and is a similar number to that of 2006 ($3.99 billion). Moreover, it is a significant increase when considering the recent annual investment in China has been only around $2 billion to $3 billion. Accordingly, last year, Korea accounted for 3.3 percent, of the total foreign investment in China, which was higher than 2.6 percent in the previous year. In addition, at the end of last year, Korean companies’ cumulative investment in China was $59.82 billion.

While Korean companies’ investment in China rapidly grew, Japanese companies greatly reduced their investment there. Therefore, the annual investment gap between the two countries in China has narrowed to $300 million, KITA has noted.

Japanese companies’ investment in China last year was only $4.33 billion, which was 38.8 percent lower than the previous year. When taking into consideration that Japan’s investment in China was around $7 billion for three years since 2011, which was double that of Korea, last year’s investment was an exceptional figure.

According to the trade agency, Korea’s highest investment in China in eight years is understood as Korean companies gaining interest in entering Chinese domestic markets now that the settlement of the Korea-China FTA is helping to mature the economic cooperation between the two countries. It is expected that the scope of investment will expand, not only because of the reduction of tariff on items owing to the FTA but also because of the opening of service sectors.

Clearly, while the FTA does provide investment opportunities for Korean firms, the bilateral trade between both sides is vulnerable to external pressures and also geopolitical developments.

Some economists have criticized the Korean government for promoting FTAs in such a way as to make the number of FTAs and not their contents the central object. They have pointed out that the conclusion of an FTA should not be its own object since an FTA is only a means to strengthen competitiveness and enhance efficiency, and since Korea’s basic FTA policies focus on external expansion, the effects of trade liberalization are less than what are expected. It remains to be seen how the effects of the Korea-China FTA pan out.

Tuesday, March 10, 2015

Restrictive Internet platform in Korea

First published in The Korea Herald.

The Korean government has finally announced its plans to start removing the troublesome ActiveX software from public websites later this month in order to create a more user-friendly Internet environment.

For long, this tech-savvy country has been stuck in a time warp with its slavish dependence on Internet Explorer.

ActiveX controls were one of the many troublesome regulations that President Park Geun-hye vowed to remove in her signature deregulation initiative, and it is good to notice that the government is moving fast.

It is a software framework that defines reusable software components in programming language and has become an integral part of the country’s Internet landscape.

Because it is a nonstandard software, it sometimes has trouble interacting with different browsers and is not really appropriate for mobile platforms. In particular, the system requires users to submit authentication certificates issued by local authorities, making it impossible for people to buy products or make financial transactions online without using Internet Explorer with the ActiveX plugin. In addition, websites of government bodies also use this technology for Internet security.

The Ministry of Government Administration and Home Affairs announced on March 3 that it would draw up a set of guidelines to remove ActiveX controls from public websites and implement it later this month.

The government has been seeking to help develop alternative technologies to replace the ActiveX controls, the home ministry said, adding that private sector website operators would also join the move to get rid of them in cooperation with other ministries.

Accordingly, the Ministry of Science, ICT and Future Planning is currently in charge of similar efforts vis-a-vis the private sector. The ministry is also planning to complete its private-sector ActiveX removal efforts by the end of this month.

However, one should not get our hopes too high. Back in 2009, the government and the Korea Communications Commission announced these very same objectives and even set up a task force. They grandly stated that they would make it mandatory for online shopping malls and financial institutions to provide subscribers with an alternative to ActiveX.

It was loudly cheered at that time, but then slowly forgotten, and the policy gathered dust. The same issue is now being revisited and it is hoped the authorities walk the talk.

To provide a little context to this situation, the Korean government was among the first to encourage shopping and banking online, but many people were concerned about Internet safety. The goal was to make Internet shopping very secure, so the government created its own system to authenticate the identities of online buyers. To make purchases, shoppers had to supply their names and registration numbers and apply for government-issued “digital certificates,” which they could present to sellers as proof of ID. This required the additional plug-in ActiveX ― which worked in tandem only with Internet Explorer, the browser that reigned supreme at that time.

Times changed and technology advanced, but the authorities continued with this piece of regulation. As a result, in Korea, when using Web browsers such as Chrome Firefox or Safari, online shopping often begins with a warning that the ActiveX plugin is required.

Those who use Apple computers or have installed Linux variants ― which cannot run Internet Explorer ― are virtually banned from doing any online financial transactions.

They have to either partition their computers and install Windows on one side, or rely on their office desktops, PC rooms and helpful neighbors.

It is really vexing, and I should know, having been a victim of this digital discrimination myself. I replaced my desktop with iMac way back in 2008. While I refuse to have anything to do with Internet Explorer, and also replaced Windows with Ubuntu on my laptop, I had to reluctantly install Windows on a partition of my Korean wife’s iMac, since she has to do most of the shopping and bank work online.

The funny thing is that Microsoft now supports ActiveX in Internet Explorer only as a legacy technology and actively discourages the use of the protocol. In fact, in a security advisory put out by the company a few years ago, the company actively discouraged the use of ActiveX.

It said: “Unfortunately, ActiveX controls are like any other software program ― they can be misused. They can stop your computer from functioning correctly, collect your browsing habits and personal information without your knowledge, or can give you content, like pop-up ads that you don’t want. Also, ‘good’ ActiveX controls might contain unintended code that allows ‘bad’ websites to use them for malicious purposes … . Here’s a good rule to follow: If an ActiveX control is not essential to your computer activity, avoid installing it.”

However, the Korean authorities appear to have ignored the warnings. So it is about time they are straightening things out. This will not only ease the hassles for customers but also grow the e-commerce business.

Last year, the Federation of Korean Industries carried out a survey on this issue and found that Koreans overwhelmingly approve the scrapping of the ActiveX framework, citing it as a hindrance.

According to a survey by the lobbying group for the country’s large conglomerates on 700 people nationwide, 78.6 percent of respondents said they wanted ActiveX software to be discontinued and replaced by a more up-to-date support system that is not so restrictive.

Going into details, the federation said 79.1 percent complained the framework made it a hassle to purchase products online, with 71.7 percent saying it affected bank transactions.

“This is the reason why despite Korea’s advanced information technology infrastructure, the proportion of its online shopping sector compared to its GDP, is much smaller than the United States, Japan and China,” the federation claimed.

For that matter, retail e-commerce sales in the country are expected to reach $36.76 billion in 2015, according to the latest eMarketer estimates of e-commerce and total retail spending around the world. Those figures give South Korea the third-largest retail e-commerce market in the Asia-Pacific, after China and Japan.

There is no doubt that if ActiveX is scrapped, it will breathe new life into the domestic online market place that could attract more buyers at home and abroad. It will go a long way in boosting the e-commerce market in the country, making it a growth engine.

Monday, February 9, 2015

Korea's growing M&A activity

First published in The Korea Herald.

Mergers and acquisitions in Korea scaled new heights last year as companies undertook massive restructuring and big deals were struck.

According to the Global M&A Market Review published recently by Bloomberg, the M&A market nearly doubled to $79.7 billion in 2014 from the previous year. This is also four times more than the $20.4 billion recorded in 2011.

It is not very difficult to guess the reasons for the M&A boom. For starters, many companies were sitting on massive cash piles, while the slowdown in the economy and their weak earnings forced businesses to restructure and discard their poorly performing units.

A string of megadeals including the merger between Daum Communications Corp. and Kakao Corp. and the merger between Samsung SDI and Cheil Industries contributed to the growth in the total M&A volume.

Other notable deals were the acquisition of Oriental Brewery by Belgium’s Anheuser-Busch InBev and the acquisition of Tyco Fire & Security services by The Carlyle Group.

One recent megadeal that made headlines involved Korea’s biggest chaebol, Samsung Group, which struck a deal a few months ago to sell four of its chemical and defense affiliates to Hanwha Group for 2 trillion won ($1.8 billion).

According to industry experts, we can expect more M&A this year given the cheaper financing costs under low interest rates and also because of moves by the Korean government to tax companies sitting on huge cash piles.

In October last year, the Bank of Korea cut its benchmark interest rate by a quarter percentage point to 2 percent, matching a record low set in the aftermath of the global financial crisis. It is widely expected to cut rates again to boost the tepid economic growth -- its next monetary policy committee meeting is scheduled for Feb. 17.

News reports suggest that as many as 700 local companies are likely to be hit by a new tax on internal cash reserves, which is part of the government’s three-pronged taxation initiative announced in August.

Companies that have more than 50 billion won in capital will face the new tax. A single 10 percent tax will be imposed on companies that use less than 80 percent of their annual revenues for investment, wages and dividends from this year.

The initiative is a cornerstone of the economic plan of Finance Minister Choi Kyung-hwan to boost the domestic economy by forcing businesses to use some of their cash to raise employees’ wages, invest in facilities and raise dividends for investors. However, some companies might try to reduce their cash reserves by actively seeking out acquisitions.

As economic theory suggests, the M&A benefits are manifold. They can generate cost efficiency through economies of scale, enhance revenue through gains in market share and even bring the companies tax gains.

To narrow it down, the benefits can be listed as increased value generation, increase in cost efficiency and increase in market share.

All this should be good news for the Park Geun-hye administration, which announced proposals in March last year to give a much-needed boost to M&A activity and expand the local market.

It aimed to increase the volume of the local M&A market by announcing proposals to amend and abolish a number of regulations so as to encourage corporate takeovers and more private-equity-backed M&A deals. The plans include easing regulations on private equity firms and providing capital for M&A.

To boost private equity-backed M&A deals, the government said it would discard voting right restrictions and also strict disclosure obligations placed on PEFs under the fair trade law.

The government also announced it would make it easier for PEF-owned companies to list their shares on the local stock market. Until now, strict rules on investor protection blocked such companies from going public.

Other steps include expanding the size of a fund for the M&A activities of startups and small and medium-sized firms to around 1 trillion won within the next three years, and also introducing tax-exemptions for M&A deals carried out through a share exchange.

On the face of it, the volume of M&A activity in 2014 appears to suggest that the government push seems to be working. However, a closer look shows that not everything is as rosy as it looks.

The number of M&A deals were actually lower at 468 last year, versus 482 in 2013. A few deals have been very large, which in turn pushed up the total volume of transactions.

The M&A deals that occur in Korea take place mostly to improve the financial health of large companies by selling affiliates, rather than acquiring venture companies related to the new growth engines. In contrast, overseas M&A deals are more focused on means to secure new growth engines.

Mergers between affiliates of a large company and the division of a large company into affiliates for a shift in corporate governance continues to be one of the most active types of domestic deals.

Meanwhile, business transfers and mergers by large companies to diversify business -- apart from a few -- have declined due to uncertainty in the economic environment. Abroad, deals between companies in the same industry and across all different industries for external growth and business diversification are active. The Korean M&A market has clearly been dominated by acquisitions of domestic companies in the country. While cross-border deals are still lower, accounting for less than 3 percent of the total M&A transaction volume. This needs to pick up for the companies to make a global mark.

Without a doubt, much more progress is needed in the M&A sphere in Korea, and one should not just go by the transaction volumes that have been recorded. It is still in a nascent stage.

Another point that needs to be made is something that has been largely glossed over by economic commentators -- the impact of M&A activity on economic growth.

Neoclassical economic theory is primarily concerned with why M&A occur and views them either as responses to industry shocks, such as new regulations, technologies, liquidity constraints and competition or as responses to industry life cycles. The implications of M&A for economic growth, however, are largely ignored.

In Korea too, the consequences of M&A remain less studied than the reasons why mergers occur. Maybe it is time for Korean economists to do a comprehensive study on the impact of M&A activity on the domestic economy. It is bound to provide valuable policy advice to our policymakers.

Thursday, January 29, 2015

Korea-India economic ties slow to take off

First published in The Korea Herald.

It has now been five years since the India-Korea Comprehensive Economic Partnership Agreement ― a de facto free trade agreement ― went into effect, but the trade statistics do not present a very rosy picture.

It was widely anticipated that the CEPA, which came into effect in January 2010, would lead to more bilateral trade and investments. South Korea has abolished tariffs on 93 percent of Indian imports, and India has done the same on 75 percent of Korean imports. Besides, the agreement sought to increase the interactive trade account, as it includes investment in various sectors like goods, services and even intellectual property.

However, according to the latest statistics released by the Korea International Trade Association, while bilateral trade has slightly improved, it is still way below expectations.

Bilateral trade between both countries was $12.15 billion in 2009, which spiked to $17.11 billion in the first year of the agreement. However, since then, it has been a rollercoaster ride, increasing to $20.55 billion in 2011, and then falling to $18.84 billion and $17.57 in the following two years. In 2014, bilateral trade inched up a little to $18.05 billion ― well below the CEPA target of $30 billion.

Clearly, there is something wrong here. Even as Korea’s bilateral trade with the U.S. and the European Union has leaped, its economic relationship with India appears to be stumbling.

It is a wonder what happened to the grand proclamations that were made when the CEPA was being negotiated and finally signed.

Clearly, while considerable scope exists, it is not possible to pump up trade between both sides without government efforts. It is all the more important for South Korea to do so, as its economy has thrived on export-led industrialization.

Now, coming to the foreign investment figures. According to the latest statistics published by Eximbank Korea, total Korean investments in India to the end of 2014 amounted to just $3.53 billion ― 1.3 percent of their $270.43 billion overseas investments.

In comparison, Korean companies have pumped $49.69 billion into China, $15.70 billion into Hong Kong, $10.72 billion into Vietnam, $7.96 billion into Indonesia and $6.02 billion into Singapore. In the entire Asian region, Korean companies have invested $115.57 billion.

Looking at it from India’s point of view, the latest available analysis of FDI equity inflows by the Department of Industrial Policy & Promotion shows that Korea continues to rank low with only around $1.5 billion in investment.

Clearly the economic ties are still way below potential and CEPA has not really been very effective.

It is true that large Korean brands are household names in India and their strength has grown in the years since they first started operations. However, the fact remains that Korean FDI inflows have been growing at a very tardy pace, and companies seem to be keener to explore other emerging markets.

Many Korean companies were the first movers as FDI investors in India, following the spate of reforms and liberalization since 1991. They started to invest by forming joint ventures with local companies or established wholly owned subsidiaries, predominantly in automobiles and white consumer goods. With clever business models, they managed to make deep inroads into the Indian market in a relatively short period of time, led by technology giants Samsung Electronics, LG Electronics and Hyundai Motor. More recently Lotte Group, Doosan Heavy Industries and POSCO have become familiar names in the Indian business lexicon.

It may come as a surprise, therefore, that India figures quite low on the list of favored investment destinations for Korean companies.

Part of the explanation could be the nontariff barriers that continue to exist in India. The main irritants for Korean companies there are poor infrastructure, corruption, labor management, taxes, administrative services, fluctuating government policies at the central and state levels, political intervention, and customs and clearance procedures. Such uncertain policies have made investors opt for divestment or delaying their planned investment as they consider India a less attractive investment outlet than other Asian countries.

A case in point is the troubles faced by POSCO in India ever since it decided to start operations there. It has still not gotten clearance to start full-scale operations and the latest news suggests that there could be further delays.

As for Indian investments in Korea, among the noticeable investors are Tata Motors (which acquired Daewoo Commercial Vehicle in 2004); Novelis Inc., a subsidiary of Hindalco Industries Ltd. (which acquired Alcan Taihan Aluminum Limited in January 2005); and Mahindra and Mahindra (which acquired Ssangyong Motors in March 2011). Among the smaller investors are Nakhoda Ltd. and Creative. While Indian software companies such as TCS, Wipro and L&T Infotech have a small presence in Korea (with representative offices), they have not made any large commitments.

Does this mean that Korea does not offer any potential for Indian businesses? On the contrary: As an FDI destination, the nation has several strengths compared to China and Japan.

The economies of India and Korea are highly complementary in terms of factor endowment, capabilities and specialization. If the investment barriers are effectively tackled, India’s cost-effective human resources may complement growing labor scarcity and rising wages in Korea, and a number of companies may consider India an ideal destination for their relocation or global sourcing.

As experts have noted, India’s booming knowledge-based service industry complements the hardware and manufacturing-based economic structure of South Korea. India’s capability in the pharmaceutical, IT software and auto components industries usefully complement Korean competence in heavy engineering, automobiles, machinery and electronic hardware.

So it is all the more important for the two governments to become more active in sorting out the problems and realizing the full potential of the CEPA. India could make a conciliatory gesture and give permission to POSCO to start full-fledged operations.

Luckily for Korea, Indian Prime Minister Narendra Modi ― unlike his predecessor ― is business-friendly. Realizing this, most of the advanced countries are rushing to strengthen ties, with U.S. President Barack Obama even making a second state visit to India during his tenure ― something unprecendented ― and has accepted the invitation to be India’s Chief Guest at its Republic Day celebrations on Monday ― the first by a U.S. president. Modi has promised to bring sweeping economic reforms to make doing business in India easier. He is well on his way to doing it, and it not too late for the Park administration to take the initiative and sort out the problems plaguing trade and investment relations by initiating a comprehensive dialogue.

Tuesday, January 20, 2015

Curious case of Uber in Korea

First published in The Korea Herald.

Over the past couple of years, the sharing economy ― a system built around the sharing of human and physical resources ― has caught the world by storm. While the practice of sharing goods has always been common between closed groups ― friends, family and neighbors ― now the concept has evolved into a profitable business model.

It has been helped largely by the strides in information technology that led to the worldwide boom in Internet penetration and smartphone use.

The sharing economy has many advantages. It can reduce costs for available goods, services and time. You can use a product or service only when necessary, and don’t have to deal with the normal headaches. On the other hand, an owner can unlock the potential value of an item, such as a room, a vehicle or a consumer good when it’s not in use. The sharing economy also offers access to things that might not be practical to own or obtain.

Some of the most notable businesses that have boomed on the concept of the sharing economy are Airbnb, Snapgoods, DogVacay, RelayRides, TaskRabbit, Getaround, Liquid, Zaarly, Lyft, LendingClub, Fon and Poshmark.

With the range of services offered, one can rent a room or a whole home, get petsitters for dogs, allow people to borrow cars from neighbors, help people to hire others for jobs and tasks, rent bikes and cars, and even get hard cash when in need, share a home Wi-Fi network, and buy or sell used clothes.

Given the huge advantages that this system offers, similar services are bound to proliferate around the world, and most likely in technology-driven Korea.

On the face of it, people should welcome such businesses with open arms and governments should have no objections.

Then why is it that the so-called sharing economy business Uber is being hauled over the coals by the Seoul city government? And moreover, is the government unfairly targeting the app that helps summon a car for a cost?

As 2014 drew to a close, the Seoul Central District Prosecutors’ Office issued an indictment against CEO Travis Kalanick and the firm’s Korean unit for violating a law prohibiting individuals or firms without appropriate licenses from providing or facilitating transportation services.

This was immediately met with protest by the company, which was echoed by countless “sharing” enthusiasts across the world.

However, although I am all for disruptive technologies and hugely back the concept of the sharing economy, I am with the Seoul government on this case.

Over the past several months, Uber has asked the mayor of Seoul to revise the laws so that citizens can use the service without worrying about breaking the law. However, even after it was flatly refused it went ahead and started offering the service without getting clearance.

It began offering UberX as a paid service, with a base fare of 2,500 won ($2.24), with an additional 610 won per kilometer and 100 won per minute. By comparison, base fare for local taxis starts at 3,000 won plus 100 won per 142 meters and 100 won per 35 seconds.

It smacked of arrogance to believe that since they were able to operate in so many cities around the world, they should be able to operate in Seoul. Uber had no right to start services when they knew that it was a gray zone they were operating in, and had been repeatedly warned.

The company knows that under current laws, anyone using his own passenger car to carry paying customers is subject to imprisonment for two years or less, or fines of up to 20 million won.

When you want to start a flourishing business, you just don’t abuse the goodwill of the government and cock a snook at the authorities. Wait till all the regulatory hurdles are cleared and then start your business. Lobby for amending the regulation, but do not jump the gun.

To make matters worse for the company, a city ordinance has been passed to criminalize the violators and reward up to 1 million won to those reporting illegal Uber taxi operators beginning in January. Using a private car for a taxi service is also punishable by an immediate six-month suspension for that car.

Coming to my second point of defense of the Seoul government decision. The reason Uber has grown so quickly worldwide is because it is not regulated the same way that traditional taxi services are. Proponents of the service say that it’s about time for monopolistic, overregulated city cab services to be broken up. They argue that people deserve options, better pricing and more nimble technology, which Uber offers.

However, the way I see it, taxis are a public utility and the government has every right to regulate them. Imagine if companies started offering other public utilities without regulation ― a sure recipe for chaos and disaster.

It is not very easy to get a taxi service license in Seoul, and the market is already saturated with around 6,000 taxis. Given this, the service offered by Uber has the potential to deal a severe blow to the taxi industry, whose hands are tied due to excessive regulations, even as the upstart “illegal” taxis are waiting to pounce on the opportunity. Most taxi drivers come from a lower-income background, and it is like kicking them in the stomach; the issue is not about depriving “unregulated” taxi drivers of additional income as Uber is making it out to be.

On top of it all, data privacy is something that has not been clearly addressed by the company. There are also doubts about the screening process and the training that is provided to the Uber drivers, which has become an issue in many cities. Because of the way their system operates, the safety concerns will only increase. Maybe that is why Uber claimed that “UberX is safer than any other mode of transportation in Seoul.”

However, safety is not really an issue for the public when it comes to taxis in Seoul. The taxis here are amongst the safest in the world, unlike in, say, Delhi. It is just an ad line that holds no water. Moreover, the company says the same thing in all places it operates, but molestation cases are not dying down. The company has a standard answer when faced with such cases: We are cooperating with the authorities. We are just a platform to connect people to drivers and are not directly responsible.

Given these clouds, it will be better for the company to clear all the regulatory hurdles before offering the service here, instead of readying for a legal battle.

Having said that, now that the Seoul government has taken on Uber, it should ensure that the misdemeanors of its taxi drivers ― for example rash driving or refusing passengers ― should be strictly dealt with. It should push forward regulations strengthening the crackdown on taxi drivers, and increase the supply of alternative transportation. Once the public stops complaining about the existing taxi services, the government will be on a firmer footing.

Sunday, January 18, 2015

Corruption and business ethics in Korea

First published in The Korea Herald.

On most occasions, the Korean government latches on to any new international report or study that commends the country, be it on competitiveness, ease of doing business, regulatory reforms or education. However, there has been remarkable silence from bureaucrats and government officials regarding the latest Corruption Perceptions Index recently released by Transparency International.

In its much-awaited yearly report, the nongovernment organization ― calling itself the “global coalition against corruption,” with 100 national chapters and an international secretariat in Berlin ― gives a comparative list of corruption worldwide. The organization is widely recognized as a corruption crusader and has built up a solid reputation since it was established in 1993.

The cornerstone of its work is the annual Corruption Perceptions Index. It also publishes the Global Corruption Barometer, Bribe Payers Index and Government Defense Anti-Corruption Index.

The CPI quantifies the perceived levels of public sector corruption around the globe, and over the past two decades has become one of the key corruption indices worldwide.

It focuses on corruption that involves public officials, civil servants or politicians. The data sources used to compile the index include questions relating to the abuse of public power and focus on bribery of public officials, kickbacks in public procurement, embezzlement of public funds, and the strength and effectiveness of public sector anticorruption efforts. The scores, therefore, provide a reflection of the amount of corruption faced by ordinary people and businesses in a country.

In the 2014 CPI, Korea ranked 43rd among the 175 countries surveyed. The Asian countries and territories ranked above Korea include Singapore (7), Japan (15), Hong Kong (17), UAE (25), Qatar (26), Bhutan (30), Taiwan (35) and Israel (37). Interestingly, Korea was ranked No. 39 in 2010 and No. 40 in 2005.

What does this tell us?

Clearly, Korea has a long way to go when it comes to tackling corruption. As long as its government and politicians are perceived to be corrupt, this will hamper investment and affect growth. With other territories in the vicinity being perceived as less corrupt, it is natural for investors to eye them first.

It is true that over the years the country has made many efforts to tackle corruption and has tweaked a lot of regulations to ensure transparency. Anticorruption acts have also been enacted. But it clearly is not enough.

Excessive bureaucracy, weaknesses in corporate governance, inconsistent application of laws and regulations, and nontransparent regulatory processes are among the challenges that have been cited by many foreign companies in Korea.

Moreover, the corruption watchdog Anti-Corruption and Civil Rights Commission has been criticized for its poor ability to focus on corruption issues as it lacks independence and efficiency. It does not have a mandate to independently initiate investigations, but it can request cooperation from the relevant agencies, such as public prosecutors.

In the 2013 Global Corruption Barometer, the current government’s anticorruption efforts were found to be “ineffective,” with 39 percent of those surveyed perceiving that the level of corruption had increased in the previous two years. Moreover, 70 percent of households evaluated Korean political parties as being “corrupt” or “extremely corrupt.”

In last year’s World Competitiveness Report issued by the World Economic Forum, Korea ranked 26th out of 144 countries, its lowest position in 10 years. It also ranked 33rd in terms of transparency of government policymaking, and 97th in terms of public trust.

For that matter, for many years now the foreign media has constantly reported that the chaebol in Korea are so powerful that the ACCRC has no jurisdiction over them, even when they are involved in tax evasion, bribery and price-fixing. Except for a few outlets, the local media has been largely silent on the close nexus between politicians and the large business houses. It is evident that despite the protests by civil society, they are only getting stronger.

Each time a big-shot chaebol head is snagged by the prosecution and convicted by the courts, our politicians step in to bail them out of their misery. The constant refrain one hears from them is their “importance to the national economy.” Earlier the courts too used the same logic to give suspended sentences and a rap on the knuckles to “powerful” white-collar criminals, but thankfully now such judgments are rare.

In fact, it has become a global joke, and Korea has become a laughing stock for continuing with the policy of frequently granting special presidential pardons to businessmen, but the thick-skinned politicians have blinders and shamelessly continue their routine.

In the latest instance, ruling party politicians started howling for presidential pardons for some prominent chabeol owners in end-December. Finance Minister Choi Kyung-hwan too is reported to have recommended for the presidential office to release top chaebol owners.

By their logic, if you are rich and powerful with a huge business empire, you can freely break the law, because putting you behind bars will hamper your company, and since your company is so important for Korea, it will hamper economic growth and push Korea down from its advanced country status. What they do not realize is that if businessmen are given a free hand to evade taxes, set up slush funds and cheat investors, the country will automatically fall in the eyes of the world. Overseas investors will be put off, which will only stall economic growth ― much more so than if the businessmen are behind bars.

President Park Geun-hye has vowed to administer the law strictly and treat all criminal offenders equally. To that end, she has not granted special pardons to any politicians or businessmen in prison since taking office in early 2013. It remains to be seen whether she will succumb to pressure this time around. If she does, then many of the businessmen will continue to have scant regard for the law and Korea’s corruption ranking will continue to slip. If she does not, then it will be a strong signal that the law is equal for everyone.

As it is, Korea is perceived to have a pervasive system for conveying favors in return for monetary consideration, along with lax enforcement of existing anticorruption laws.

President Park should walk the talk and make abolishing corruption a top priority by overhauling the anticorruption systems. She should go beyond the Kim Young-ran law ― a comprehensive anticorruption bill aimed at public officials, likely to be enacted by January 2016 ― and end the practice of dealing out pardons to convicted chaebol chieftains.