Impact of ARFP on Korea’s financial services

First published in The Korea Herald.


A very important development in the first week of June that will bring huge benefits to the financial services industry in Korea has gone largely unnoticed here.

Finance officials and regulators from six Asia Pacific Economic Cooperation members, including Korea, who are leading the development of the Asia Region Fund Passport concluded a week of meetings in Singapore to iron out the details of the proposal and announced that it was on track to be launched in 2016.

The countries ― also including Australia, New Zealand, the Philippines, Singapore and Thailand ― aim to cut down on incompatible or overlapping financial regulations that may hinder the marketing of managed funds between participating economies.

Six other APEC members ― Hong Kong, Indonesia, Japan, Malaysia, Taiwan and Vietnam ― are also closely following the discussions on the rules and arrangements, hoping to join the initiative.

So what exactly is the ARFP, and why is it important?

Two years ago, finance ministers from Australia, Korea, New Zealand and Singapore signed a statement of intent on the establishment of the ARFP. Accordingly, it aims to “facilitate the growth and competitiveness of financial markets in the region and the fund management industry, creating a common framework that has the effect of reducing regulatory inconsistency and overlap faced by collective investment scheme operators seeking to offer collective investment schemes in multiple economies.”

Once it is established, fund managers in a participating economy will be able to offer a single product across multiple markets, which will result in a larger client base that will grow the fund size sufficiently to realize economies of scale.

At the same time, more competition, a higher number of funds and funds under management will help keep the fund sizes at an optimal level so as not to erode fund performance. Investors will also benefit from improved efficiency as direct access to offshore funds results in the elimination of an extra layer of fees and commissions charged by local operators.

According to the APEC Policy Support Unit, once the ARFP is fully up and running, it could save the region’s investors $20 billion annually in fund management costs, offer higher investment returns at the same or lower degrees of risk and encourage the establishment of locally domiciled funds that could create 170,000 jobs within five years.

In its study of the potential costs and benefits, the APEC unit said that following the introduction of the ARFP, using a conservative assumption of 20 percent increase per annum in assets under management over 5 years, almost all the involved Asian funds markets would achieve better efficiency.

Currently investors in some Asian economies have limited products available to them. This is due partly to strict regulations in those economies that have discouraged fund managers from distributing foreign funds in local markets. Without a broad range of foreign products to choose from, investors have to place the bulk of their funds in local products.

International portfolio diversification can facilitate the possibility of reducing risks only if values of cross-market correlations of returns are low. The benefits of a more optimal portfolio can be transferred to investors in the form of better returns for risks.

The ARFP can also bring significant benefits to the wider regional and global economies by supporting the recycling of savings toward productive investments that are critical for the region’s growth.

The benefits can also extend beyond financing investment needs. The ARFP can introduce to local funds industries foreign technical know-how, competitive pricing and higher standards of disclosure and performance. These promote efficiencies in the local fund industries, resulting in greater global competitiveness of the Asian funds management industry, the APEC unit has noted.

One of the measurable contributions of the ARFP to the economy is the potential increase in employment numbers in the funds industries in Asia. An essential feature of the ARFP is that it will increase the demand for funds to be domiciled in Asia. This would offer increased job opportunities, not only to manage the funds but also to service the fund structure.

What does it mean for the asset management industry in Korea?

Korea has a mature funds management industry. The first contractual-type equity investment scheme was introduced in 1970, after the promulgation of the Securities Investment Trust Business Act in 1969. The development of the funds industry experienced a setback during the Asian financial crisis in 1997-98. However, it has since quickly recovered.

Assets under management ― the sum of fund assets and assets under discretionary management ― by the 86 asset management companies totaled 685 trillion won ($616 billion) at the end of 2014, up 9.1 percent or 57 trillion won from 628 trillion won a year earlier. Fund assets increased 14 percent to 382 trillion won. Publicly offered funds increased 7.4 percent to 204 trillion won, while private equity funds increased 22.8 percent to 178 trillion won. Discretionary assets increased 3.4 percent to 303 trillion won during the same period.

The aggregate net income of the asset management companies for 2014 came to 424.8 billion won, up 14.1 percent from 372.4 billion won during the last year. A total of 20 companies reported net losses for the period.

However, despite its success, the funds industry is fragmented and markedly skewed toward equity that dominates the total funds’ AUM.

While regulators in Korea have been keen to pursue market liberalization, the industry still faces challenges. For instance, industry analysts have noted that the sale of offshore funds is facing tight regulatory hurdles, including preferential tax treatment for onshore versus offshore funds. As a result, the presence of foreign funds in Korea has been relatively weak.

The ARFP is a therefore a very good initiative to give a boost to the industry in Korea.

However, the Financial Supervisory Service should also keep in mind the risks that are involved with the creation of the ARFP.

As in any cross-border financing solution, shocks in one market can be amplified and transmitted to other markets very quickly. This can become worse given the enhanced interconnectedness and efficiencies of the transmission and intermediation process currently available.

While the deepening integration of financial markets will help promote the financing of investment, care should be taken to see that they do not accentuate the risks associated with large and volatile capital flows.

The FSS should ensure that Korea’s regulations and market practices are upgraded and harmonized in tune with regional standards. It should also keep investor protection foremost in mind, minimizing systemic vulnerabilities and maximizing market transparency before finalizing the plans to rollout the ARFP.

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Stock price limits and circuit breakers

First Published in The Korea Herald.

Starting next month, the Korea Exchange will expand price limits and introduce market-wide circuit breakers that should provide some relief for stock traders and retail investors.

Price limits and circuit breakers are used by many stock exchanges and regulators to counter severe price movements in financial markets, and Korea is no exception. Price limits are maximum percentages or values that a security or derivative contract can rise or fall in a trading day. Circuit breakers are trading halts triggered by sharp price movements, and can be imposed on either an individual financial instrument or the market as a whole. They were first adopted by the New York Stock Exchange and other U.S. exchanges in 1988.

Circuit breakers had been recommended by the U.S. Presidential Task Force in the aftermath of the stock market crash on Oct. 19, 1987, when the Dow Jones Industrial Average fell 508 points, or 22.7 percent. These circuit breakers were not triggered until a decade later, on Oct. 27, 1997.

Korea’s bourse operator has announced that, starting June, the price limit is set to rise to 30 percent, while the circuit breaker would halt trading for 20 minutes if the benchmark index falls 8 percent and 15 percent and shut down the daily session if the index plunges more than 20 percent.

Currently, stocks listed on the main KOSPI and tech-heavy KOSDAQ markets are allowed to move within a 15 percent price range from the previous session’s closing price. It is the first time in 17 years that the daily price cap is being revised. The existing circuit breaker allows the bourse operator to suspend trading for 20 minutes once a day if the market cap falls by 10 percent and is not triggered after 2:20 p.m.

“Although the current price limit system has contributed to stabilizing the stock market, it has hampered effective price setting by preventing the latest information from being immediately reflected in share prices,” officials of KRX were quoted as saying by the media.

It is hoped that the expanded price range will help the market better set the appropriate price in accordance with corporate values, he noted.

There is no doubt that a fair and orderly trading environment is key to maintaining a vibrant and well-functioning securities market.

Market interventions are aimed at preventing potential market disorder and restoring order in a trading environment that may be under stress. By providing a break or limit in trading, interventions are intended to provide the opportunity for information to be disseminated widely and equally, for market participants to reconsider their trading decisions rationally in light of new information and to serve as a signal of potential order imbalances in the system.

However, there is no consensus on whether price limits and circuit breakers are effective tools during crises. To date, there is still no convincing evidence of their potency.

Let us take a brief look at the two different schools of thought on the validity of these market invention systems.

As noted earlier, supporters say the systems provide investors with a cooling-off period to calm fears or provide time to digest news when there are steep declines in the markets; reduce market volatility and protect investors from excessive market volatility; provide time to restore the equilibrium between buyers and sellers; and provide the opportunity for increased information flow.

Those against market intervention, however, argue that they prevent investors from engaging in equity transactions that reflect their assessments of economic events, trapping investors in their positions. They find the tools counterproductive as they drain liquidity and diminish market depth.

The tools accelerate price movements toward the pre-announced limits as market participants alter their strategies and trade in anticipation of a market halt. In addition, they induce panic and uncertainty if the markets shut down suddenly and scare away the buying power necessary to turn a selling panic around.

The other arguments are that they are unfair to market participants with positions that benefit from volatility and deprive market participants of opportunities to raise liquidity to meet other obligations and lead to a chain of defaults.

In essence, price limits and circuit breakers deprive market participants of the opportunities to transfer risk and interrupt the price discovery process, two key market functions.

Economists have pointed out that one way to tackle this is to have the right of a discretionary halt built into the regulatory system, but use it rarely or sparingly as a deterrent. Such a deterrent would be just that ― a deterrent.

This is because, without a breaker, the price is continuously available as a barometer for investor beliefs. However, with a breaker in place, the price simply ceases to be displayed. This causes uncertainty among market participants as to what the asset is truly worth. The execution price uncertainty can also lead to misallocation of resources and the bearing of unwanted and avoidable risk.

Another alternative to such halts are “sidecars,” which have been used in the U.S. exchanges. Market orders are batched over short intervals and then matched against limit-order books, and move from a continuous auction to batch orders during extreme market moves, which would potentially slow trading down and calm markets. These procedures do not cause total cessation of trade and price discovery.

In any case, the market intervention mechanisms have been in used in many advanced countries, and one does not expect the Korean regulators to ditch the automatic system to shield the market from volatility.

It is good to know that the KRX will adopt a wider range of measures to prevent excessive market fluctuation and step up market monitoring in the first month to detect any suspicious trading activities. It is also preparing changes in the electronic trading system in cooperation with brokerage houses to introduce new functions to curb excessive stock fluctuations.

Given that, since the rules are being eased, it is absolutely necessary that the bourse operator strictly monitors trading, not just for one month, but continuously. The regulator cannot afford to let its guard down.

The stock market is an important barometer of the aggregate economy. A growing stock market signals to policymakers that sentiment is positive and investors expect economic conditions to improve. Appropriate policy action can then be taken. In a similar vein, a falling stock market signals that market participants expect bleak economic conditions. Policymakers may then take action to stimulate growth and perhaps contain inflation.

Therefore, it is very important for the stock market to function efficiently without any hiccups and the regulator should make all efforts to ensure it.

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Inadequate steps to boost foreign investment in Korea

First published in The Korea Herald.


Last week, the Korean government announced plans to attract more foreign direct investment by more than 50 percent in three years by easing regulations and focusing support on five sectors, including cosmetics and pharmaceuticals.

The Ministry of Trade, Industry and Energy said in a statement that industrial materials, petroleum products and food processing sectors would also be given strong support through regulatory changes.

Korea received FDI pledges totaling $19 billion last year, up sharply from $14.5 billion in 2013, and now aims to increase the amount to $30 billion in 2017.

Despite the sharp rise in pledges last year, South Korea still ranks low among high-income countries in the accumulated amount of FDI compared to the size of its economy.

Moreover, according to Industry Ministry data released on April 29, the total amount of reported FDI dropped 29.8 percent in the first quarter of this year to $3.55 billion compared to last year. On an arrival basis, the amount fell by 16.4 percent to $3.15 billion.

According to the UNCTAD 2014 World Investment Report, South Korea ranks No. 7 among the most attractive countries of South and East Asia for transnational companies.

South Korea’s appeal in terms of FDI is the result of the country’s fast economic development and the specialization of its industries in new information and communication technologies. However, the lack of general transparency in regulations continues to be a major concern for foreign investors. Despite the best intentions of the government, foreign investors remain dissatisfied with the ground situation and feel that there is room for improvement if Korea is to raise its competitiveness.

Therefore, it is interesting to see how foreign investment policies have changed over the years.

Policy developments

Korea’s liberalization of foreign direct investment policies was implemented in four stages. Between 1962 and 1979, foreign investment was made mainly through international commercial loans and loans from international foreign institutions like the World Bank, rather than through foreign direct investment, because there were concerns that foreign investors might take control of domestic industries. As a result, both these types of foreign loans constituted more than 80 percent of the total foreign capital in Korea.

The introduction of foreign capital reached its limit in the 1980s due to the second oil crisis and the declaration of a moratorium by developing countries. With this in mind, Korea began to lay the foundations of an FDI policy, by eliminating the 50 percent ceiling on foreign ownership of businesses in various sectors.

Since establishing the “Five-Year Plan for FDI Liberalization” in June 1993, the Korean government has revised and complemented the plan in a continued effort to further open its markets to foreign investors. With the launch of the WTO system in 1995 and South Korea’s entry into the OECD in 1996, the country responded to the changing circumstances of the global economy, while enhancing the competitiveness of domestic industries and expediting the opening of its markets.

Policies for facilitating FDI have been promoted, with foreign ownership of existing stocks permitted in April 1995 and “friendly” M&As in February 1997. In 1997, the Asian financial crisis affected Korea badly. Against this backdrop, the Korean government quickly responded to solve the structural problems of the Korean economy, which were seen as causing the crisis.

Recognizing that attracting FDI was a shortcut to overcoming the economic difficulties, the government actively promoted policies to encourage foreign investment, while drastically liberalizing FDI and portfolio investment. In May 1998, ceilings on foreign ownership of the companies which were listed on the stock market or registered on the KOSDAQ were lifted, and hostile foreign M&As with domestic companies were completely liberalized, thereby allowing foreigners the right to freely own stakes in Korean businesses.

In June, foreign land ownership was totally guaranteed, and all types of business categories, except two, were opened to foreign investment. As a result, the liberalization rate reached 99.8 percent as of December 2001.

These government policies designed to liberalize foreign investment led to the securing of foreign currency and contributed to strengthening the foundation of the national economy by helping Korea to create jobs and overcome the financial crisis sooner than expected. Since then, there have been a series of reforms and the economy has become liberalized.

The government even formulated ambitious plans to make the country a Northeast Asian business hub.

In 2002, the Korean government announced a new “business hub strategy” that differed significantly from the traditional strategy in two ways: First, the essence of the hub strategy was to also harness the business opportunities of the neighboring countries; at the same time, it aimed to produce high value-added goods and services by bringing world-class multinational corporations, foreign capital and technology, as well as specialized professionals, into Korea.

It was expected that by developing as the “business hub of Northeast Asia,” the Korean economy would prosper in the context of a world economy characterized by deepening globalization and rising regionalism.

The government’s view was that to be a regional business hub, Korea must become a logistics hub, a hub of multinational corporations and a financial hub in the region, by using its geoeconomic advantage and creating a business-friendly environment.

Following President Kim Dae-jung’s announcement of a basic policy direction to make Korea a Northeast Asian business hub in January 2002, the Korean government’s action plan for that aim was agreed on in the following July.

A “Draft Law on Designation and Administration of Special Economic Zones,” a key legislation of the business hub plan, was submitted to the National Assembly in October 2002.

The plan was not just a vision. The Korean government backed it up by announcing a concrete action plan, then submitting a draft law for special economic zones.

This new vision, radically improving the market environment, was listed as one of President Roh Moo-hyun’s 10 national agenda. In particular, he established a task force to develop and implement the new vision, specializing in the three main sectors ― logistics, finance and industry. The logistics dimension was considered crucial given Korea’s strategic location between Japan and China.

The administration also took steps improve the business and operating environment for multinational corporations through socioeconomic and institutional reforms such as labor market conditions, chaebol, liberalization of immigration policy and tax benefits at the national level.

In other words, the attraction of multinationals became a top priority for the Korean economy and the major component of Korea’s new globalization strategy. Since then, many policies have been implemented to encourage foreign investors.

President Lee Myung-bak’s administration continued this policy of attracting foreign investors and frequently announced that Korea strove to be the business hub of Northeast Asia.

In effect, it is now 13 years since the strategy was first announced and many enabling policies have been introduced.

Today, the Korean government offers various incentives to foreign-invested companies that have great potential to contribute to the Korean economy. These include tax support, cash grants and site location support.

Korea provides various types of support for foreign investments in industrial complexes, which are designated and developed strategically for industrial development. Likewise, foreign investment zones, free trade zones, and free economic zones in Korea offer favorable investment environments to foreign investors.

Foreign investment zones are designated to attract foreign investment. The zones are largely divided into two types: complex and individual. Complex-type foreign investment areas are sections of national or local industrial complexes that have been designated for small- and medium-sized foreign-invested companies, while an individual-type zone is designated as the individual location of a foreign-invested company.

Despite the best intentions of the government, foreign investors feel that more changes are required if Korea is to compete with emerging economies like China and India.

So then, what is the reality on the ground?

Competitiveness ranking

As we have seen, recent reports on competitiveness continue to note that Korea still has some way to go.

Korea dropped in global competitiveness in 2014 for the second year running to 26th out of 144 economies in the annual report by the World Economic Forum. Korea ranks especially poorly in indicators for institutions, which gauges the severity of regulations, at 82nd, labor market efficiency at 86th, and financial market development at 80th.

Korea “loses further ground in two of the three areas in which historically it has performed poorly. It now ranks 82nd (down eight places) in the institutions pillar and 86th (also down eight) in the labor market efficiency category. Although stable, the financial market development pillar remains a sore point (80th, up one), preventing Korea from closing the competitiveness gap with the three other Asian Tigers,” the report said.

If the government is serious about luring more investment and competing in Asia for investors, it has much left to do in terms of improving the business environment and raising South Korea’s rank in all the parameters. Periodically announcing that steps are being taken to lure foreign investors is not enough.

Attracting foreign investors 

There is no doubt that the Korean government’s attitude toward foreign direct investment is positive, and senior policymakers clearly realize the value of FDI. However, many international surveys by private-sector organizations have repeatedly shown that foreign investors are put off by the country’s complicated and overlapping regulations in areas such as foreign exchange transactions and the employment of foreign nationals.

A majority of foreign investors feel that the main problems in the country are a lack of openness and transparency of laws and regulations, a rigid labor market and unstable labor relations and less internationalized human resources than Hong Kong and Singapore.

Most importantly, a majority feel that English proficiency is one of major stumbling blocks for Korea to become a business hub.

As the surveys point out, despite the various liberalization and promotion efforts by the Korean government, internal barriers, namely, domestic regulations and transparency problems, remain.

They feel that Korea lacks a real long-term development project for the future of its economy. The Northeast Asia Hub project, which appears to be Korea’s only strategic response to counter the rise of China, is an “ad-hoc” initiative. The danger is that the country is destined to gain a role as a logistics “niche” by taking advantage of Korea’s geographical position between China, Japan and the Russian Far East, but miss out on greater and wider economic opportunities.

The piecemeal opening of several localized FEZs within Korea is far from sufficient to make FDI here an alternative option to FDI in China. China itself has FEZs in so many cities with attractive conditions supported by its very strong economic growth and the usual low costs.

The only real long-term option for Korea would be to turn the entire country into a free trade zone: This move would transform Korea into the “Free Trade Hub” of Northeast Asia by taking advantage of its value-added high-tech sectors and first-class infrastructure and creating a very competitive services platform for the surrounding countries following the examples of Singapore and Dubai. This is a proposal that China can never offer because it is too large to consider such an economic model.

Investors also find that flexible service support from governments and bureaucrats is a lot less satisfying compared to those from other governments in the region. The implementation of FDI by other governments has a high level of flexibility in helping foreign companies to establish their businesses. Their FDI promotion program and marketing implementations are also very active and supportive to those investors. On the contrary, many investors doubt that the cooperative actions undertaken by government ministries, agencies and provincial governments in Korea are productive or efficient.

Basically, there are too many administrative procedures and documents that take too long. Investors can get only superficial support from the government. The role of each ministry and provincial government should be clearly specified so that conflicts of interest do not arise between the central government and provincial governments.

In the worst case, the conflict between each bureau and the provincial government may cause a negative image of Korea among investors because the credibility of the market will deteriorate. Investors also wish the government and agencies would work more efficiently with improved communication skills and a clearer vision.

One common complaint by most investors is the lack of consistency and reliability of regulation. They feel that Korea’s regulatory framework is still heavily mired in red tape and a lack of coordination between administrations. This problem is worsened by the administration’s poor external communication of laws and regulations as well as by the scarcity and lack of precision in English translations of official documents.

Greater attention should be paid to streamline all administrations toward more transparency and a more “user-friendly” service with all rules and regulations in all industries and sectors duly translated into English and easily available.

The list of regulations ranges from daily audit reports to highly complex certification, testing and bidding procedures. The interpretation of regulations is an even bigger issue since it leaves room for bureaucrats to maintain their old habits of meddling in the economy ― with a particular eye on foreign companies. One favorite tool to go after foreign companies is a tax or regulatory audit.

Further, no matter how comprehensive or good a country’s laws may be, they will only have limited effectiveness if law-enforcement agencies cannot or will not enforce them fairly and consistently. When laws lose their efficacy, they are no longer respected as rules of behavior. The complaints reflect a perceived lack of consistency in the enforcement of the law, which itself is a factor that contributes to corruption.

Foreign businesses are sensitive to the level of corruption since it is a source of business risk. If laws are enforced based on the whims of law-enforcement agencies, they can hardly be expected to retain their efficacy or be respected by society. Excessive government regulation is also a major source of corruption. Unnecessary regulation is the product of bureaucratic formalism commonly found in underdeveloped administrative systems. There are so many complicated regulations in Korea administered at the discretion of inconsistent officials that most people find it impossible to observe all the rules. In addition, officials apply regulations on a selective basis, arbitrarily enforcing them at times and against specific targets.

The government needs to make a more liberal and fair business environment for multinational companies to invest. It should deregulate many inefficient obstacles and operate long-term economic policies with consistency. It should also deal sternly with corruption.

The efficiency of Korean ports and airport facilities also lags behind that of other comparable Asian cities like Shanghai or Hong Kong. The investors are worried that despite the high quality of Korea’s port infrastructure, the competitiveness of these ports is being challenged by stiff regulations and unsatisfactory cargo handling and transportation procedures. At Incheon airport, the advantage of excellent cargo handling skills is offset by sudden and steep price increases that eliminate its competitive edge.

Particular attention should be paid to improve the predictability of new regulations and limit price changes as much as possible so that companies can react accordingly and are given enough time to incorporate those changes into their business plans.

Most investors feel that despite its importance as an import and export country, Korea’s logistics sector still lags behind international standards. Logistics costs in Korea are among the highest in the world, and investors deem it important to improve this situation for the development of foreign business in this country.

Improvements in local infrastructure and regulations are necessary to position Korea as a strategic logistics hub.

Intellectual property rights issues also continue to be a major barrier to attracting foreign direct investment in Korea. The issue is a very serious one and Korea’s bad image in this respect repels foreign investors willing to bring advanced technologies and processes to this market for fear of losing billions of dollars to piracy, counterfeiting and fraud.

The Korean government has devoted much effort in recent years to improving the situation, especially by improving the related legal framework in the FTAs it has signed. In addition, the Korean government has improved its enforcement organization, but production, marketing, importing and exporting of counterfeit and pirate goods are still not deterred effectively in the ordinary marketplace because enforcement actions by the Korean authorities lack continuous efforts.

Korea can easily secure a competitive edge just by seriously enforcing its existing IPR regulations. The strict observance of those IPR regulations, if achieved, will have a very positive impact on the country’s overall image with foreign investors.

Aside from that, the cost of production is much higher. The recent increase of domestic labor costs will cause serious problems for competitiveness in productivity. Eventually, manufacturing facilities will move overseas.

What is more, many existing foreign investors feel that Korea is not successful in promoting its image abroad for foreign investors, mainly due to the lack of coordinated government efforts for the promotion of FDI and the less-than-satisfactory performance of Korean investment promotion organizations abroad.

The latest move by the Park administration, while a step in the right direction, also needs to take into account all these factors that hinder foreign investors.

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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.

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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.

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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.

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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.

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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.

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