Samsung's Note 7 fiasco and perils of 'ppalli-ppalli' culture

First published in The Korea Herald.

The last few weeks have been tumultuous for tech giant Samsung Electronics, as it has been knocked down by the battery explosions of its latest flagship smartphone Galaxy Note 7 across the globe.

Samsung recalled 2.5 million Note 7 smartphones in September 2016 after a number of the units spontaneously burst into flames. Faulty batteries were blamed at first, and it issued replacement phones it claimed were safe. However, some of the new phones suffered the same problem, and the firm asked consumers to switch off their Note 7s on Oct. 11. All production and sales of Note 7 handsets has now been stopped, and the model has been withdrawn from the market.

South Korea’s No. 1 conglomerate is still struggling to recover, having initially regained composure and immediately ordered a global recall only to stumble and fall when the replacement handsets also overheated and exploded.

After numerous cases of exploding batteries and a botched replacement program, with sales now discontinued worldwide, some analysts predict the Note brand is finished for good and will be given a quiet burial.

It is a pity, because the Note was truly a game changer and this year’s model got the best reviews the product line had ever seen.

When it was first launched in 2011, many mocked its large screen size, with Wired even lamenting that its “comically huge” 5.3-inch screen made the device too big for pockets and thumbs alike. But ultimately, its popularity meant that even archrival Apple was forced to follow suit.

Another feature that was ridiculed was the stylus, which also has been imitated by competitors. The fourth edition was the first smartphone to be tailored for virtual reality -- that too is being aped by others now.

It won’t be an understatement to say this is an unprecedented crisis that will haunt the group for a long time to come.

Samsung has now lowered its operating profit estimate for the third quarter to 5.2 trillion won ($4.6 billion) from the original estimate of 7.8 trillion won. It also lowered its expected revenue to 47 trillion won from 49 trillion won.

Most analysts have pegged the cost of the Galaxy Note 7 fiasco at about $4 billion, including recall expenses and lost sales, with the mobile division even expected to report an operating loss.

As Fitch Ratings has noted, potential long-term brand damage from the recall and production suspension of the Note 7 is a greater threat to its credit profile than the direct financial impact, which will be buffered by ample liquidity and a strong balance sheet.

“Fitch believes that the benefits of Samsung Electronics’ diversified product portfolio have reduced its vulnerability to this shock. ... However, the problems with the Note 7 have raised long-term uncertainty about its handset operations, as the issues with the flagship model have highlighted weaknesses both in R&D capabilities and the company’s capacity to efficiently remedy serious hardware defects.”

The ratings agency then went on to add that industry experience, such as the decline of Nokia and BlackBerry, shows how successful manufacturers can lose market share particularly quickly in the handset business. This is due to the fast pace of technological change and the frequency with which many consumers change their handsets.

These are indeed tough times for Samsung, but I think it will not be long before it overcomes it, given the tenacity of Koreans.

On that note, I should also add that the crisis that Samsung faces now can be linked to the unique “ppalli-palli” culture in the country.

The Korean term means “fast; quickly; hurry up” in English. Every single economic achievement the nation has reached to this day is linked to this culture. Koreans do everything as quickly as possible with dedication to achieving the set goals as soon as possible. As a result, it has become the main work ethic that is understood by all employees and strictly enforced by bosses.

For that matter, ppalli-ppalli is so ingrained in Koreans that mothers don’t tell their children “come along.” They say “ppalli-ppalli wa,” or “come quickly.” My Korean friends and even wife do the same to me!

I worked in the European Union business lobby in the country for close to eight years during my 12-year stay here and have come face-to-face with this culture numerous times. Although a foreign organization in name, it used to be run as a typical domestic company since the chief operating officer was Korean. While this culture makes employees put in long work hours, it does not really enhance productivity.

Most Korean companies want things to be done as quickly as possible without due checks and balances. Meeting the deadline is more important than doing a perfect job.

Although Samsung heir apparent Vice Chairman Lee Jae-yong is trying to totally transform the work culture at his group, it can be successful only if those lower down adhere to the changes. Which, I believe, is not the case.

This is evident from the fact that the botched recall raises questions about how carefully Samsung researched safety issues around the original Note 7, as well as the replacement.

Samsung has often challenged itself by cramming sophisticated components into a new device in time to beat the launch of the latest iPhone. This time, it advanced the launch of the Note 7 to a month before the launch of iPhone 7 to gain an advantage.

It is reasonable to assume that everyone from the tech engineers, designers and suppliers were told to strictly adhere to the deadline ppalli-ppalli, and somewhere down the line appropriate safety checks were ignored or glossed over.

Moreover, faced with trouble when the first batch of recalls took place, it should have taken the time to analyze the mistake, but wanted to get back in the game ppalli-ppalli. It found a quick fix -- blaming the overheating on a batch of Samsung SDI batteries -- and deployed it with characteristic speed and efficiency. Unfortunately, the diagnosis was wrong.

It seems highly likely that Samsung’s ppalli-ppalli efforts to pack ever more power in these sleek devices may have contributed to the Note 7’s tendency to overheat and even explode by cramming a high-capacity battery into too small a space.

Typically, lithium-ion batteries have been relatively safe, but as batteries grow ever denser, that leaves an ever thinner margin for error in design and manufacturing. Being ppalli-ppalli in evaluating their performance is a definite no-no -- something the Samsung executives behind the project did not comprehend.

Hopefully, it will be a lesson for the company and it will bounce back ppalli-ppalli.

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Government role in corporate debt restructuring

First published in The Korea Herald.


The hot topic in Korean corporate circles today is undoubtedly the moves by the government and state-run policy banks to bail out the ailing shipbuilding and shipping companies.

Given the importance of these sectors in Korea and their prolonged financial distress, it is understandable that the government has pushed the panic button. The process of bailing them out has been set in motion with some sort of consensus reached between the Finance Ministry and Bank of Korea.

BOK Gov. Lee Ju-yeol has cautioned against the central bank mobilizing its power to print money in the ongoing corporate restructuring. He was echoing the sentiments of critics, who have raised worries over the government’s possible misuse of the money-issuing authority.

The current crisis in the shipping and shipbuilding industries is very much evident. Once regarded as the backbone of Korea’s economic growth and job creation, they have been reeling from mounting losses caused by an industry-wide slump and increased costs.

Hanjin Shipping and Hyundai Merchant Marine -- the major South Korean shipping companies -- face trouble with mounting losses and have applied for creditor-led debt restructuring.

The top three shipbuilders have also failed to clinch a single deal in April, according to latest data.

They only managed to win five construction deals over the first four months of this year, which is only around 5 percent of the average amount posted in previous years.

Daewoo Shipbuilding & Marine Engineering and Hyundai Heavy Industries, failed to win any deals in April. Samsung Heavy Industries has not earned any orders this year for the first time.

Given this dismal situation, it is important to ask: Is active government involvement in corporate debt restructuring really advisable?

No doubt, corporate debt restructuring is an important step toward recovery. But what are the limits to which the government should stick to without putting a burden on other sectors and more importantly tax payers?

Given the interlinkages between corporate debt problems on one hand and the recovery of the financial system and overall economy on the other hand, several governments across the world in the past have introduced measures to help facilitate the process of corporate debt resolution.

However, there are a number of complications involved.

Corporate debt problems have often created real risks of disruption of activity as companies have difficulties meeting their working capital needs to secure production. This in some cases led to weaker capacity to service existing debt and further deteriorated their balance sheet.

The slowdown of activity has contributed to unemployment and the nonperforming loans have endangered the already weakened banking system and further reduce the ability of banks to extend credit, slowing down the recovery.

As experts have noted, debt overhang becomes self-perpetuating as corporations are unable to deleverage by retaining earning or issuing equity because of recession, but recession is also being prolonged by the high level of debt.

The government’s rescue efforts of embattled corporates typically entail direct fiscal costs and may have increased the contingent risk in the future due to moral hazard. The resolution of corporate debt problems thus became an important part of the recovery strategies across a range of countries affected by the crisis.

A past IMF Working Paper, “Government Involvement in Corporate Debt Restructuring: Case Studies from the Great Recession” is worth noting here, and should be mandatory reading for Korea’s Finance Ministry officials at this time.

The paper surveys corporate debt restructuring episodes in Latvia, Russia, Spain, UAE, Ukraine, and the United States and provides a comparison of modalities of government.

It notes that in cases in which the number of troubled corporations is small, their potential macroeconomic importance is limited and the financial system is sound, the rationale for government’s involvement in corporate debt workouts is weak.

“In contrast, when corporate debt problems are widespread, with potentially sizable macroeconomic consequences, and market failures inhibit debt workouts on the required scale, a comprehensive approach involving government could be warranted. In these cases, however, the framework of such involvement needs to be carefully defined.”

That choice typically involves weighing the costs of intervention against the need for a speedy restructuring. The costs are not limited to the direct financial ones, and include indirect economic costs that could eventually appear from both action and inaction of the government.

Governments’ specific role in an effective corporate debt restructuring process typically includes provision of: appropriate legal foundations; mediation and incentives for out-of-court resolutions; direct financing; and facilitation of restructuring.

Large-scale debt workouts may require an overhaul of the legal framework and corresponding enforcement mechanisms.

Direct government financial assistance to facilitate debt restructuring is generally observed in cases in which debt problems are pervasive and impose negative externalities on the economy.

The incentives may include compensation to creditors for lengthening maturities or providing guarantees for corporate loans. Sometimes, such support also includes direct lending to companies that are viable but are unable to access markets on their own.

In addition to direct assistance to corporations, governments may provide indirect support to the corporate sector via assistance with bank recapitalization and liquidity provision.

This approach is being tried in Korea now.

The IMF paper notes that country experiences with wide-scale corporate debt restructuring in the past have been mixed and have involved lengthy and difficult processes.

“While outcomes varied by country, the past experience indicates that a properly designed strategy would generally make the best use of limited fiscal resources, target interventions where needed most, leverage market-based solutions and private resources, bolster credit enforcement and insolvency laws, and preserve credit culture.”

Tailoring a corporate debt restructuring strategy to individual country circumstances is a complex process involving attention to a number of key factors -- including policy coordination, analysis of data to assess the dimensions of the debt problem, reform of the legal and institutional framework for enforcement of credit, particularly the corporate insolvency law, identifying the rationale for government financing and coordination with financial sector restructuring, particularly with respect to banks.

“The direct financial costs of government interventions varied significantly across countries. While the fiscal and contingent costs in corporate debt restructuring episodes are somewhat smaller compared to the costs of financial sector support, they ranged from zero (where no fiscal resources were deployed) to 10 percent of GDP,” the IMF study notes

“However, it should be noted that contingent risks built up in the years before the crisis due to corporate sector debt have in some cases already translated into fiscal costs.”

In what should be positive for the Korean government at this stage, in general, the debt restructuring and related measures have helped avoid large-scale corporate insolvencies in the sample countries. These measures provided confidence to the markets and stabilized expectations.

However, they also came at a direct and indirect cost to the taxpayer. These interventions weakened the governments’ balance sheets as they accepted assets of questionable financial value in exchange for new resources that had ample alternative use in crisis times.

That is something that the Korean policymakers will have to monitor and work out as they race to bailout the ailing firms.

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Amending retail price maintenance rules

First published in The Korea Herald.

The Korea Fair Trade Commission is all set to take a decision on amending the “Guidelines for Review of Resale Price Maintenance” as the public comment period has just concluded.

Resale price maintenance, or RPM, is a system in which the manufacturing firm determines and enforces the price at which distributors resell its products. Hence, it is also known as vertical price-fixing, price protection, or the practice of imposed prices.

Until now, RPM has been deemed illegal in Korea, and companies that are caught engaging in this practice are fined heavily by the antitrust agency because it is considered anticompetitive.

The proposed amendments will allow RPM under certain conditions, more specifically if it “enhances consumer welfare.” It will still be generally illegal; firms need to prove that it does indeed help consumers if they want to get permission for the practice.

The FTC guidelines prescribe specific review criteria for the enforcement of Article 29 (1) of the Monopoly Regulation and Fair Trade Act on resale price maintenance, or RPM. For this purpose, it received public comments for about three weeks from May 23 to June 13.

The current guidelines treat minimum RPM as illegal per se regardless of whether there are justifiable reasons for using it, such as consumer welfare enhancement.

“The proposals state that the minimum RPM is highly likely to be deemed illegal as a matter of principle. However, when the consumer welfare enhancing effect of the minimum RPM concerned outweighs its anticompetitive effect, the minimum RPM can be permitted as an exception,” the agency has noted.

“The burden of proving reasons to justify the minimum RPM, such as consumer welfare enhancing effect, is on the (concerned) enterprise.”

Following the FTC’s move, there are some questions that need to be asked: Should RPM continue to remain illegal? And what will be the impact of the proposed amendments?

For many years, until antitrust agencies across the world struck it down, RPM used to be a common practice for manufacturers to set a minimum price for retailers to sell their goods. It ensured a minimum price of resale and avoided price competition.

Globally, public policy toward RPM has taken various forms.

It has been prohibited in Canada since 1951 as a restrictive practice against the public interest. In the United States resale price maintenance is authorized in some but not all the states, and also in interstate commerce between “fair-trade” states. In Sweden the practice has been prohibited since 1953. In the United Kingdom legislation introduced in 1964 prohibits RPM, except for classes of goods specifically exempted by a special court.

There are quite a few criticisms of RPM, which led it to being termed illegal.

It is argued that the system artificially inflates prices. Consumers lose out as they have less discretionary income to spend on other goods. Moreover, it is also allocatively inefficient as the price is likely to be above marginal cost.

By setting high prices, manufacturers will have no incentive to remain internationally competitive. RPM enables an easy profit margin in domestic markets, but the result is that inefficient manufacturers may stay in business and lose the market incentive to cut costs and become more efficient.

It also seems out of place today when the culture of shopping around on the Internet for the cheapest products is so widespread.

The likelihood of collusion is high, particularly in a market gravitating toward either manufacturers or retailers. By making RPM illegal, it prevents the formation of cartels.

On the other hand, the supporters of RPM say that it helps retailers to be more profitable. Manufacturers may also prefer it, because if the retailers are profitable then more of their goods will be sold.

It also prevents price wars among retailers as they will not start undercutting each other.

It has also been argued that RPM provides help for smaller retailers, who cannot buy in bulk, to remain profitable. On the other hand, it enables manufacturers to reward shops who promote their products through advertising. This will help firms invest more in future products.

Consumers benefit because they don’t have to waste time searching around for the best deal. They know the price will be the same regardless of where they buy it.

Moreover, its supporters note that minimum RPM is different from price-fixing by cartels. Classic price-fixing is typically referred to as horizontal price-fixing, as they are arrangements between competitors operating at the same level of distribution. On the other hand, vertical arrangements are those between businesses operating at distinct levels of distribution.

In price-fixing, the initiators are competitors who realize that they will be better off if they minimize group competition. With minimum RPM, a single manufacturer influences downstream retailers’ behavior through an increased markup, so they will compete more aggressively on nonprice dimensions, even as competition among manufacturers is not affected. This enhances intra-brand nonprice competition and overall inter-brand competition.

They note that minimum RPM is a business practice that can benefit companies and consumers in stark contrast to price-fixing conspiracies.

Incidentally, in recent years, there is increasing recognition of the potential competition benefits of RPM arrangements and many antitrust agencies are relaxing the rules to make them more flexible.

In 2007, the United States moved away from the per se prohibition. In December 2014, the Australian Competition and Consumer Commission authorized an RPM agreement for the first time, recognizing that the supplier had limited market power and that the arrangement benefited consumers. The European Union guidelines also state that parties to an RPM agreement have the “possibility to plead an efficiency defense” under certain circumstances. In a number of jurisdictions in the region, RPM agreements are not singled out, but are subject to the same test as other vertical agreements.

South Korea is also now moving in the same direction, and it remains to be seen how flexible the FTC amendments will be.

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Effectiveness of warnings on cigarette packs

First published in The Korea Herald.

As expected, South Korean tobacco-makers and retailers have expressed their opposition to the Health Ministry’s new antismoking policies, which require all firms to fix health warning illustrations on their cigarette products. However, the ministry is not being swayed by their arguments and has refused to stand down.

The new measures, which will be implemented later this year, require health warnings consisting of text and images to be printed on the top 50 percent of the front panels of all cigarette packets. In addition, retailers have to display the front panel bearing the warning graphics to customers.

The graphics have to show tobacco’s harmful effects as well as health conditions that may be triggered by heavy smoking, including heart disease, lung cancer and possible birth defects.

The tobacco lobby claims the government is interfering with their rights to product design, as almost all cigarette packs will look more or less identical.

Dismissing their arguments, the Health Ministry has said that some 80 countries overseas require cigarette products to have warning illustrations, and of them, 63.8 percent make it mandatory for the warnings to appear in the upper portion of the packs.

From an economic standpoint there are many questions that need to be asked in this tug-of-war.

Have warning graphics discouraged smokers?

Have these policies affected the revenues of tobacco-makers in countries where this policy has been implemented?

What has been the economic impact on tobacco firms?

According to a recent report by the U.S.-based nonprofit organization Campaign for Tobacco-Free Kids, despite the numerous public reports on the risks of smoking, studies show that a large number of smokers have inadequate knowledge of the health effects of smoking.

“While some smokers generally know that tobacco use is harmful, they underestimate the severity and magnitude of the health risks and tend to perceive other smokers to be at greater risk for disease than themselves,” it notes

Knowledge of the health risks of smoking is even lower among people with lower income and fewer years of education because of limited access to information about the hazards of smoking.

Therefore, health warnings on cigarette packs have been found to inform smokers about the health hazards of smoking, encourage smokers to quit and prevent nonsmokers from starting to smoke.

Studies by the International Tobacco Control Policy Evaluation Project, an international cohort study that surveys adult smokers in 19 countries, provides much of the evidence base for health warnings.

According to ITC research, adult and youth smokers report that large, comprehensive warnings reduce smoking consumption, increase motivation to quit and increase the likelihood that they will remain abstinent following an attempt to quit.

It shows graphic warnings are more effective than text-only warnings in leading people to think about quitting and deterring them from having a cigarette.

Further, ITC studies of smokers in Australia, Canada, the United Kingdom and the U.S. revealed that graphic warnings are more effective than text-only warnings at making smokers think about quitting and deterring them from having a cigarette, and that larger, pictorial warnings are associated with increased quit attempts.

Evidence from Canada, the first country to implement graphic warnings, shows that after controlling for price, graphic warnings significantly decreased the odds of being a smoker and significantly increased the odds they would try to quit.

After Singapore introduced their graphic warnings in 2004, 28 percent of smokers surveyed reported smoking fewer cigarettes because of the warnings; 14 percent of the smokers surveyed said that they made it a point to avoid smoking in front of children; 12 percent said that they avoided smoking in front of pregnant women; and 8 percent said that they smoked less at home.

Since Thailand introduced their second set of pictorial labels in 2006, 44 percent of smokers said the warnings made them “a lot” more likely to quit over the next month.

In Brazil, after the introduction of new graphic warnings in 2002, 67 percent of smokers said the new warnings made them want to quit.

Given this, the Korean Health Ministry may be right to conclude that these measures will be effective in South Korea, home to almost 10 million smokers, where an estimated 57,000 die every year due to smoking-related diseases.

According to the World Health Organization, warning labels on tobacco products constitute the most cost-effective tool for educating smokers and nonsmokers alike about the health risks of tobacco use.

“In many countries, more smokers report getting information about the health risks of smoking from warning labels than any other source except television,” it notes.

Countering the claims by tobacco-makers, it says, “For decades, the tobacco industry has taken advantage of the package as a venue for creating positive associations for their product. The use of graphic pictures is an important means of replacing those positive associations with negative associations, which is far more appropriate given the devastating impact of tobacco products on global health.”

All these arguments seem valid, and if true, the tobacco-makers will certainly see a dent in their revenues once the policy is implemented.

However, I am not really convinced that it will lead to a dramatic fall in the number of smokers in Korea.

In 2014, the National Assembly approved an 80 percent increase in the price of cigarettes, from 2,500 won ($2.17) per pack to 4,500 won, in an effort to curb smoking. The new bill took effect on Jan. 1, 2015.

While in the initial few months, there was a decline in the revenue of tobacco-makers here -- as many smokers started experimenting with e-cigarettes -- it was short-lived, and the revenues have again increased a year later. The only beneficiary has been the government, whose tax kitty has swelled.

As noted by Maastricht University researchers in a recent article in Health Psychology Review, “Scary graphic warning labels are a popular tool among policymakers, but there is no clear consensus within the scientific community regarding their efficacy.”

The researchers looked at an initial selection of 295 publications exploring “fear appeals,” including graphic warning labels, then eliminated studies that had methodological problems.

“Not only is there little evidence that could support the use of graphic warning labels, but if you combine the evidence that is available, it turns out that at best, the use of graphic warning labels only has a small effect, while in the worst case, it may even backfire,” they noted.

It remains to be seen how the policy pans out in South Korea -- with a tobacco market widely perceived to be  demand ineleastic -- but my bet is in the long run it will make little difference.

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Tackle illegal political funding for sustainable growth

First published in The Korea Herald.

With the general election in Korea just a couple months away, a recent report by the Organization for Economic Cooperation and Development appears to be timely.

The report, “Financing Democracy,” takes a comparative approach to examining how the funding of political parties and election campaigns has evolved, and how regulations across OECD member and partner countries have been established.

From an economic standpoint, this is important because it shows how the politician-business nexus can hamper economic growth. As long as it continues to exist, vested interests will rule supreme, rather than national interests.

In particular, the report assesses the risks of policy capture through the funding of political parties and electoral campaigns, identifies regulatory loopholes and implementation gaps in existing policies, and suggests a comprehensive approach to integrity, including issues such as lobbying and conflicts of interest.

Korean policymakers, in particular the National Election Commission, could do well to heed the recommendations the report makes. They should particularly focus on the cross-country comparison, as it features detailed country case studies of Canada, Chile, Estonia, France, Korea, Mexico, the United Kingdom, Brazil and India -- providing in-depth analyses of their political finance mechanisms and challenges in different institutional settings.

As the report notes, money in politics is a double-edged sword. It is a necessary component of the democratic process, enabling the expression of political support as well as competition in elections.

“Yet, the increasing concentration of economic resources in the hands of fewer people presents a significant threat to political and economic systems. If the financing of political parties and election campaigns is not adequately regulated, money may also be a means for powerful special interests to exercise undue influence, and ‘capture’ the policy process,” it notes.

For example, access to public procurement has been used by elected officials to “return the favor” to corporations that have made significant contributions to their campaigns or to exclude those that supported their opponents. While high-spending areas such as infrastructure and urban planning are particularly vulnerable to the risk of policy capture, any policymaking process can be a target of powerful special interests.

This sort of leverage has always been used in Korean elections, and to a larger extent in presidential elections. That the Four Rivers Restoration Project and energy diplomacy bulldozed through by former President Lee Myung-bak were mired in corruption immediately comes to mind.

The OECD report points out that countries’ experiences have revealed that several shortcomings still exist and are vulnerable to exploitation by powerful special interests.

Many countries struggle to define and regulate third-party campaigning in particular, to prevent the rechanneling of election spending through supposedly independent committees and interest groups.

At the moment, only a few countries, such as Canada, Ireland, the Slovak Republic, the United Kingdom and the United States have regulations for third-party campaigning. Significantly, Korea is missing from the list.

While Korea bans all anonymous donations to political parties, the information disclosed needs to be organized in an intelligible and user-friendly way to facilitate effective public scrutiny. Civil society organizations and the media can only be effective watchdogs if substantive political finance information is publicly available for their analysis. That is not the case here.

It is essential to tighten lobbying standards for sustainable and broad-based economic growth. While disclosure of private interests by decision makers is widely adopted by countries to manage conflict-of-interest situations and identify suspicious financial flows in public decision-making, verification and auditing of disclosure forms are not strictly practiced, more so in Korea.

As the report notes, since being enacted in 1965, the Political Fund Act in Korea has undergone 24 revisions for the purpose of guaranteeing the fair provision, and transparency, of political funds. The term “political funds” is defined as money, securities or goods provided to persons engaged in political activities, including political parties, in addition to expenses that they need to undertake political activities, including elections.

With the aim to guarantee the proper provision of political funds, secure the transparency of political funds and contribute to the sound development of democratic politics by preventing illegal political funding, the act lays out many basic principles.

In August 2005, the National Assembly revised the act so that all corporations and groups were fundamentally prohibited from making political contributions with the aim of initiating political reforms and addressing problems with illegal political funds.

However, is it strictly followed? It appears not, going by the regular news of slush funds by corporate honchos and raids by prosecutors.

Under the act, any political party may collect party membership fees. However, it does not set an upper limit on the fees that may be paid by an individual political party member.

When an association that raises political funds for a National Assembly member or a candidate to run in an election for public office submits a financial report, it is required to disclose the personal information of donors who make contributions exceeding a set amount. This rule is often flouted in Korea.

According to financial reports submitted by political parties in 2015, the total membership fees collected was $52 million, 25.8 percent of their total income of $201.3 million. South Korea’s ruling Saenuri Party collected $26.4 million in membership fees, which made up 27 percent of its total $97.6 million income. The main opposition New Politics Alliance for Democracy party, now renamed The Minjoo Party of Korea, collected $21.2 million, making up 23.1 percent of its $91.7 million total income.

Since it was not an election year, the external funding for campaigning has obviously not been included. However, elections are due in April this year, and there will obviously be more funding details available at the end of the year.

Unlike Western political parties, party membership fees in Korea are too insignificant to be of importance for political party financing. It is no secret that the candidates receive massive funding from outside sources and under the table.

In the current context of economic crisis, there is a need for more transparency in public life. Particular attention should be paid to risks to the independence of political actors and public office holders as well as risks of conflicts of interest, even undue influence and corruption, related to money in the political sphere.

Political finance disclosure combined with adequate enforcement capacities has been recognized by international standards as a key policy instrument for promoting effective transparency and integrity in party and campaign financing. It is time the authorities in Korea started enforcing existing rules, and if necessary tightened the rules with regard to corporate funding of political parties.

The lack of transparency in political funding in Korea poses alarming risks of corruption. This is because private contributions effortlessly turn into a conduit for buying favors.

The current law punishes violators of political funding more severely, but the president’s special amnesty powers have long been abused. Many politicians and businessmen convicted of political funding fraud have been pardoned by whichever president is in power.

More transparent, competitive and realistic election campaign funding management is a must for the development of democracy. It will go a long way in ensuring the sustainable and broad-based economic development of Korea, which will propel it to an advanced-nation status.

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Economic impact of terrorist strikes

First published in The Korea Herald.


The recent dastardly terrorist attacks in Paris shocked the world, with countries scampering to tighten security in preparation for any eventuality.

Even countries like Korea that have had no terror attacks from Islamic jihadists have gone on high alert, and the administration is tightening measures to make sure that no untoward incident happens.

While the nation’s security, human casualties and material losses are important aspects of these inhumane attacks, what should also be considered is the economic impact of a terrorist strike -- especially on countries like Korea, which are highly dependent on a few sectors.

A study released last month by ratings agency Moody’s shows that terrorist attacks significantly weaken economic activity, with long-lasting effects on the economy.

The study measures the impact of terrorism on a country’s economic growth, investment growth, government expenditure and cost of government borrowing, according to the report “Terrorism Has a Long-lasting Negative Impact on Economic Activity and Government Borrowing Costs.”

“For example, in 2013 the 10 countries most affected by terrorism took an immediate and significant hit to growth, dampening GDP between 0.5 and 0.8 percentage points,” the report noted. “Even worse is that the negative impact continues for years after the attack, taking up to five years for the effects to peter out.”

Investment growth takes an even greater immediate hit, with Moody’s estimating for the same episodes that investment growth declines between 1.3 and 2.1 percentage points.

During the time period studied, terrorism was concentrated in a few countries. For example, more than 60 percent of all incidents in 2013 were in just four countries, with the majority of attacks occurring in Iraq (24 percent) and Pakistan (19 percent).

Terrorist events also materially dampen economic activity and investment in mature economies, the report noted. Moody’s analyzed the economic impact of the Sept. 11, 2001, attacks in the U.S., the 2004 bombings in Spain and the 2005 bombings in the U.K., all of which resulted in significant human casualties and infrastructure damage. In each case, the effect on economic activity and investment was significant and lasted several years.

Moody’s study consisted of a sample of 156 countries between 1994 and 2013.

In another interesting study published in the International Monetary Fund’s Finance & Development journal in June, the authors reach the same conclusion.

“The effects of terrorism can be terrifyingly direct,” it notes. “But terrorism inflicts more than human casualties and material losses. It can also cause serious indirect harm to countries and economies by increasing the costs of economic transactions.”

The article explores the economic burden of terrorism, focusing on three: national income losses and growth-retarding effects, dampened foreign direct investment, and disparate effects on international trade.

It notes that rich, large and diversified economies are better able to withstand the effects of terrorist attacks than small, poor and more specialized economies.

Unfortunately, Korea falls into the specialized category given its dependence on just a few engines of growth.

The article states that specialized economies may not have such resilience. Resources such as labor or capital may either flow from an affected sector to less productive activities within the country or move to another country entirely.

“A terrorist attack against such a nation is likely to impose larger and more lasting macroeconomic costs.”

Increased terrorism in a particular area tends to depress the expected return on capital invested there, which shifts investment elsewhere. This reduces the stock of productive capital and the flow of productivity-enhancing technology to the affected nation.

The authors analyzed 78 developing economies over the period 1984–2008 and found that on average a relatively small increase in a country’s domestic terrorist incidents per 100,000 people sharply reduced net foreign direct investment.

There was a similarly large reduction in net investment when the terrorist incidents originated abroad or involved foreigners or foreign assets in the attacked country.

The study suggests a troubling association between terrorism and foreign direct investment, both of which are crucial for emerging economies.

“It is generally believed that there are higher risks in trading with a nation afflicted by terrorism, which cause an increase in transaction costs and tend to reduce trade.”

Although terrorism may reduce trade in a particular product because it increases transaction costs, its ultimate impact may be either to raise or reduce overall trade.

Terrorism also influences immigration and immigration policy. The traditional gains and losses from the international movement of labor may be magnified by national security considerations rooted in a terrorism response, the authors note.

These above-mentioned studies hold useful lessons for Korea, which is highly dependent on trade, tourism and private consumption to sustain growth.

As recent history has shown, the impact of a local tragedy on consumer sentiment in Korea is huge.

In the aftermath of the Sewol ferry tragedy -- where more than 300 people died when it sank on April 16 last year, most of them students -- the economy suffered when private consumption dropped drastically.

It plunged the country into deep mourning, dragging down economic growth -- the slowest for more than a year -- partly because of sluggish consumption.

Consumer sentiment struggled to recover for months after the incident and the fallout lasted longer than expected.

With consumer sentiment remaining feeble, companies delayed investment due to uncertainty over the economic outlook, further depressing the economy.

More recently, the Middle East respiratory syndrome outbreak in Korea dealt a severe blow to the tourism sector and dampened consumer spending, almost crippling the economy.

Thirty-three people here died from MERS since it was first detected in May, making it the largest outbreak outside the Middle East.

South Korea’s export-led economy, which has been hit by slowing global demand for its goods, together with sluggish consumer demand at home, certainly does not need another tragedy.

It is right of the government to take rigorous steps to prevent terror attacks, even though many may consider it a little over the top. The Korean economy is currently very fragile and the administration is on the right path.

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Take gov’t projections with truckloads of salt

First published in Korea Herald.


A recent media statement issued by the Seoul Metropolitan Government that got wide coverage had me in splits.

According to the note that was issued to mark the 10th anniversary of the Cheonggyecheon Stream Restoration Project -- which removed an elevated freeway and transformed it into a lush walkway through the heart of Seoul -- which was faithfully picked up by all of local media without any question, 190 million tourists annually visit the landmark.

“Some 190 million Koreans and tourists are estimated to have visited the stream since its restoration by former President Lee Myung-bak on Oct. 1, 2005. The number is expected to exceed 200 million by early next year.”

These figures were obviously cooked up by some government official and can be understandable to a certain degree -- making extrapolations based on certain data collected over a few days every year are part and parcel of economic studies. But what took the cake was the detailed breakup of the nationalities of people who visited the stream.

We are told that from 2011 to August this year, 1.8 million tourists from China, 399,000 from Thailand, 256,000 from Japan, 133,000 from Taiwan and the U.S. and 290,000 from the rest of the world visited the stream.

There are no details of how the estimation was arrived at or the methodology used. But that didn’t deter the news from getting wide coverage.

First, keep in mind that the stream is close to 6 km long with 22 bridges and has various entry points. Ordinary residents (including expats) who work in the bustling business district have to cross the stream whenever they leave their office to go for appointments, coffee, lunch or transit back home.

Second, there is no single entry point and entrance gate where one can sit and take count of the number of people visiting -- to extrapolate based on the average of a few days.

Third, since there is no entrance or record keeping, how can one be sure that the person who strolls across the stream is from China, India, North America, Europe or Timbuktu?

But the SMG was confident enough to dish out the numbers and the local media was complacent enough to take it at face value.

The reason I have brought this up is not because I do not trust the government. But I do not blindly trust what the Korean government officials say with regard to economic projections of their pet projects. No one should.

Recently, the government designated Aug. 14, a friday, as a temporary holiday -- since the actual 70th Liberation Day fell on Saturday -- to increase domestic consumption. Finance Minister Choi Kyung-hwan grandly announced that it would increase domestic spending to around 1.3 trillion won ($1.1 billion).

“When this happens, local companies will also earn more and will require more staff. In turn, they’ll need to hire more employees. The holiday will encourage a ‘halo effect’ throughout South Korea,” he said.

Absurd as it was -- one extra day off generating so much economic benefit to pull the country out of its economic misery -- no one questioned him.

The government logic was that it would enhance the people’s nationalism and encourage domestic consumption. With the economy greatly affected by the MERS outbreak and other external factors, it could use a boost -- in the form of a nationwide holiday with plenty of activities and events in store for the public as well as tourists.

No questions asked … the local economic reporters dutifully reported it, and it was taken as gospel.

Same thing happened with the “Korea Black Friday,” which was announced with much fanfare.

Unimaginatively named after the U.S.’ big shopping day after Thanksgiving, the largest-ever sale event -- involving about 26,000 stores encompassing department stores and online shopping malls from Oct. 1 to 14 -- was supposed to “revitalize the economy.” Nothing of that sort has happened.

When it was announced, no questions were asked. All the questions are being raised now when it has proved to be a damp squib and the government is scrambling to dub it a success.

The same goes for the government policies to ease youth unemployment -- the nation’s jobless rate for people between the ages of 15 and 29 came to 8 percent in August, much higher than the headline unemployment rate of 3.4 percent -- by forcing companies to introduce the wage peak system.

The wage peak system advocated by the government calls for people nearing retirement age to accept lower wages with the money saved by this arrangement to be used to hire new employees.

Many companies have announced the launch of this new wage system under pressure, but no one is asking how effective it will be in getting over the main problem -- youth unemployment.

I think it is a knee-jerk reaction and is not the “magic formula” to get the youth jobs. More so, when the announcements by the chaebol are just a headline-grabbing tactic with very little changing on the ground. As was the case with the “shared growth” hyperbole.

This trend is so common -- as observed in my 11 years as a business journalist here -- that one has learned not to go by news reports about economic projections of benefits that policies will achieve.

Not that questions are never raised. The editorial writers do a splendid job doing that and pointing out the lapses. But if local economic news articles have to get credibility, the reporters on the ground need to ask the uncomfortable questions to government officials before parroting their statements -- as they do in other advanced democracies -- without wondering whether they will upset the powers that be.

One can start trusting the government economic projections only when reporters -- not just editorial writers -- start confronting government officials with uncomfortable queries and get their response instead of simply reporting their grand promises.

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Does Korea benefit from FTA with EU?

First published in The Korea Herald.


 July 1 marked the fourth anniversary of the EU-Korea free trade agreement, which entered into force in 2011. It was touted as the first of a new generation of FTAs, going further than any previous agreements in lifting trade barriers. Being also the EU’s first trade deal with an Asian country, Korea was expected to benefit immensely.
The agreement eliminated duties for industrial and agricultural goods in a progressive, step-by-step approach. The majority of import duties were removed already when the FTA entered into force. On July 1, 2016, import duties will be eliminated on all products except for a limited number of agricultural products.
In addition to eliminating duties on nearly all trade in goods, the FTA addresses nontariff barriers to trade with a specific focus on the automotive, pharmaceuticals, medical devices and electronics sectors.
It also creates new opportunities for market access in services and investments, and includes provisions in areas such as competition policy, government procurement, intellectual property rights, transparency in regulation and sustainable development.
All this has definitely had an impact on EU-Korea economic relations, with bilateral trade growing immensely. More European goods are now more visible in stores and many European companies have entered the market. In fact, the EU was the largest investor last year, injecting a total of $6.5 billion, followed by the United States ($3.6 billion), Singapore ($1.7 billion) and China ($1.2 billion).
This would seem to indicate that the deal is a tremendous success. But is it?

Looking back

The Korea-EU FTA reflects the larger trade strategies both sides have pursued from the beginning of the 21st century.

Prior to the mid-2000s, both were reluctant to enter into bilateral FTAs, preferring to conduct trade through the World Trade Organization and through regional preferential trade arrangements. However, they changed track and have been pursuing FTAs aggressively since.

The EU was a pioneer in negotiating preferential trade arrangements and used it to anchor trade relations with neighboring countries, such as members of the European Free Trade Area and as a transition mechanism in trade relations with countries slated to accede to the EU. The EU also employed PTAs to preserve preferential trade relationships with former colonies among developing countries.
The FTA with Korea was part of a new wave of EU FTAs and part of an overall strategy referred to as Global Europe that the European Commission announced in 2006. The strategy was developed to respond to the challenges faced by EU members in a rapidly globalizing economy. An objective of that strategy was to work towards reducing tariff and nontariff barriers in trade and to liberalize markets for foreign investment.
As part of the Global Europe strategy, the EU has engaged in FTA negotiations with the objective that the FTAs are more appropriate vehicles to address more trade complex issues and can serve as building blocks toward a more robust multilateral trading system.
The Global Europe strategy sets down two main criteria for selecting FTA partners: (1) that the partner country offers sufficient market potential and (2) a sufficient level of growth opportunities that would result from the removal of tariff and nontariff barriers as a result of the FTA. Based on these criteria, along with the fact that Korea had negotiated an agreement with the United States, the European Commission identified South Korea as a priority country for an FTA.
As for Korea, for nearly a decade, it was transforming itself into an FTA hub in Northeast Asia. Signing a network of FTAs was a key part of the national economic strategy of President Lee Myung-bak as well as his predecessor Roh Moo-hyun. Both presented FTAs as necessary for advancing Korea’s economic well-being.
Ongoing competitive pressure from Japanese firms, increased competition from Chinese enterprises and the rapid aging of the Korean workforce heightened the sense of urgency to boost national competitiveness.
President Lee set a goal of building a “free trade network” that by 2014 would enable over 70 percent of Korean exports to enjoy duty-free access. He explicitly tried to diversify the composition of Korea’s FTA partners, simultaneously negotiating FTAs with large advanced economies as well as with natural resource-rich developing countries.
The Korea-EU FTA also fit into his goal of creating the “Global Korea” by expanding Korea’s engagement with and presence in the international community.
As a result, negotiations were launched in 2007, and after more than two years of negotiations, both sides finally signed an agreement on October 6, 2010. Both the Korean National Assembly and the EU Parliament have ratified the agreement, and it went into effect on July 1, 2011.
In 2009, the year preceding the official signing of the deal, Korea accounted for 2 percent of EU merchandise exports, ranking 12th as an export market, and accounted for 3 percent of EU merchandise imports, ranking ninth as a source of EU imports.
On the other hand, the much larger EU market of 492 million people with a gross domestic product of $14.4 trillion was much more important to Korea. In 2009, the EU was the second-largest market for Korean merchandise exports, with a 13 percent share of total Korean exports, second to China with its 24 percent share.
The EU was the third-largest source of Korean imports in 2009 with a 10 percent share of Korean merchandise imports behind China with a 17 percent share and Japan with a 15 percent share. In contrast, the United States accounted for 10 percent of Korean exports and 9 percent of Korean imports.
Among the EU member countries, Korea’s largest trading partners were and continue to be Germany, France and the United Kingdom.

Plain statistics


In 2010, a year before the implementation of the FTA, bilateral trade amounted to $92.23 billion, with Korea having a trade surplus -- exports stood at $53.51 billion and imports from EU at $38.72 billion. By 2014, bilateral trade showed a growth of 23.65 percent to reach 114.05 billion. However, everything is not so rosy. Korea now has a trade deficit -- exports of 51.66 billion and imports of 62.39 billion.
This clearly indicates that Korean companies have not been able to take advantage of the deal to the same extent as EU companies.
This trend is also acknowledged by the European Commission in its annual report on the trade deal submitted to the European parliament and Council in March.
It noted that the EU’s share in Korea’s total imports from the world increased from 9 percent before the FTA to 11 percent in the third year of the FTA implementation. Over the same period of time, the EU‘s share in total exports from Korea declined from 11 percent to 9 percent.
In terms of EU exports, the most important categories of products were: “Machinery and appliances,” accounting for almost 34 percent of total EU exports to Korea; followed by “transport equipment,” where exports increased by over 56 percent and represent 16 percent of total EU exports to Korea.
“Chemical products”, where exports increased by 9 percent in the third year of FTA implementation, accounting for over 12 percent of total EU exports.
Other categories of products for which EU exports increased significantly since July 2011 are “mineral products,” “wood” and “pearls and precious metals.”
As far as EU imports from Korea are concerned, the main product categories are: “Machinery and appliances” accounting for 36 percent of EU imports from Korea -- they have declined by 20 percent since the FTA took effect; and “Transport equipment” accounting for 26 percent of total EU imports from Korea, showing fluctuating growth.
Significant increases were noted in plastics, mineral and chemical products.
The report also notes that EU exports of motor vehicles to Korea increased by 90 percent, accounting for 9 percent of total EU exports to Korea. On the other hand, EU imports of motor vehicles from Korea grew by 53 percent. Motor vehicles account for 11 percent of total EU imports from Korea.
EU exports of car parts to Korea increased by 6 percent since the 12-month period before the FTA, whereas EU imports from Korea of car parts increased by over 20 percent. Over the three-year period, the respective imports from the rest of the world increased by merely 3 percent.
That is as far as product classification goes, which clearly indicates that Korea’s exports are not really much diversified.
In fact another set of data also shows some disappointing results. If we look at the figures for the first half of the year starting from 2011, something strange can be seen. Bilateral trade between Korea and EU in the first six months of 2015 is actually less than the first half of 2011, before the trade deal was implemented. In 2011, bilateral trade amounted to 53.64 billion, while it registered 51.64 billion this year.
Taking a closer look, we can see that it is Korean exports to the EU that have drastically gone down, while EU imports into Korea have increased.
This is worrisome for Korean companies, which shows that the economic slump has affected them more than their counterparts in the EU. This certainly needs to be investigated by scholars.
In fact, according to a recent survey of 360 major companies in 18 EU member countries by the Korea Trade-Investment Promotion Agency, more than seven out of 10 European companies are taking advantage of the FTA to promote their business opportunities.
The awareness of the Korea-EU FTA among European companies is far higher than that for the EU’s free trade deals with other countries.
Comparable figures were 35 percent for the EU-South Africa FTA, 34.7 percent for the EU-Mexico FTA, and 28.6 percent for the EU-Chile FTA, the survey showed.
About 34 percent of the respondents said they have increased imports of Korean products since the implementation of the bilateral free trade deal.

More efforts needed

Clearly, the Korean government has its task cut out for it to ensure that the effects of the trade deal benefit both sides. At present it appears to be one-sided.
Moreover, Korea’s exports to the EU are concentrated into a few sectors, such as ships, automobiles and electronics. These three sectors represent almost 60 percent of Korea’s total exports to the EU, in contrast to exports of other countries that are much more diversified. This requires attention.
As noted in a report by the Korea Institute for International Economic Policy, in order to take full advantage of the FTA, it is necessary to not only increase the utilization rate of tariff preferences, but also improve the business environment and productivity and upgrade industrial structures in Korea.
“With more countries committing themselves to comprehensive FTAs with the EU and the U.S. and Korea relocating more of their production bases abroad, it is more likely that exports from domestic production will be replaced by overseas production. As a result, Korea’s relative advantage as an early comer in the FTA is likely to be obsolete. In this context, it is necessary to increase the utilization rate of the FTAs in the short run and to use the FTA as occasions to strengthen industrial competitiveness in the long run,” the KIEP noted.

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Pros and cons of Korea’s minimum wage law

First published in The Korea Herald.

The minimum wage in Korea has been set at 6,030 won ($5.30) for next year after weeks of debate, although the labor unions boycotted the government-led talks on the final day.
Labor union representatives walked out of a meeting of the Minimum Wage Council ― a trilateral committee of employers, employees and labor market experts to set the minimum wage through discussion ― on Wednesday. They were upset with the suggestion that there should be a cap on the increase in the minimum wage. However, the council went ahead and finalized an increase on the following day.

The Minimum Wage Act stipulates that at least one-third of all representatives on the council can decide on the rate if any party refuses to attend the negotiations more than once.
The new rate will be notified by the government on Aug. 5 after taking into consideration all objections to the finalized rate.
In Korea, the minimum wage is the lowest allowable gross wage per hour, regardless of employment status or nationality. There are some exceptions to this rule: Businesses that only employ family members or relatives living in the same residence; domestic service users; and seamen who are governed by the seamen act.
The unions initially demanded a 79 percent rise from the current minimum hourly wage of 5,580 won to 10,000 won, while employers ― represented by the Korea Employers Federation ― were pushing for a freeze. The unions lowered their demand to 8,100 won, and refused to budge from this stance, despite opposition from others on the council.
The minimum wage in Korea was raised by 7.1 percent this year from 5,210 won in 2014 ― it was 600 won in 1989 when the government formed the wage council. The latest hike, therefore, marks an 8.1 percent hike.
For comparison purposes, the minimum wage in the United States is $7.50, Japan $6.40 and the U.K. $10.
The KEF argues that the minimum wage has risen too rapidly and needs to be stabilized, voicing concerns over possible job losses and soaring production costs. On the other hand, the unions maintain that a hike would curb the nation’s income inequality and boost consumer spending.
So, who among them is right?
At face value, the logic of the unions seems right, as minimum wages protect workers from exploitation by employers and reduce poverty. Legal minimum wages are a government’s most direct policy lever for influencing wage levels, especially for workers with a weak bargaining position.
They also serve as a basic labor standard, alongside working-hours regulations and related provisions to ensure basic job-quality standards. And supporting low-wage earners is widely seen as important for promoting inclusive growth.
However, many economists do not think so. They believe that minimum wage laws cause unnecessary hardship for the very people they are supposed to help.

The argument is that while the law can set wages, it cannot guarantee jobs. The experience in most countries with a minimum wage law is that low-skilled workers are often priced out of the labor market. This is because employers typically are not willing to pay a worker more than the value of the additional product that he or she produces.
In fact, there are numerous studies using aggregate time-series data from a variety of countries that have found that minimum wage laws reduce employment.
If employers consider the wage floor too high, Workers whose productivity is valued less than the mandated wage will find jobs only in occupations not covered by the law or with employers willing to break it.
In Korea, we already have seen many highly publicized cases in recent months where nonregular and part-time workers were paid below the mandated wages until a public outcry made them reconsider.
In addition to making jobs hard to find, minimum wage laws may also harm workers by changing how they are compensated by cutting fringe benefits which are an important part of the total compensation package for many low-wage workers.
Studies have also found that the minimum wage increases generally redistribute income among low-income families rather than moving it from those with high incomes to those with low incomes.
As the Organization for Economic Cooperation and Development has noted in a recent policy brief, minimum wages are common but controversial. Currently, 26 out of 34 OECD countries have statutory minimum wages.
“Views differ about whether such support is best provided through minimum wages, or closely related policies, such as government transfers,” it noted.
In recent years, policymakers in many countries have adjusted minimum wages in the context of high and increasingly persistent unemployment, stagnant or even declining average wages and, frequently, falling incomes especially among the poorest families.
“While minimum wages are intended to support low-wage workers, the cost of employing them can be at the heart of concerns that legal minimum might reduce employment, or damage the international competitiveness of domestic firms relying on low-skilled labor,” the brief noted
Further, tax burdens too have to be taken into account.

Even at the very bottom of the wage ladder, taxes and social levies can strongly reduce take-home pay. At the same time, taxes and other mandatory nonwage labor costs also push up the cost of employing minimum-wage workers.
By having an impact on labor costs and workers’ take-home pay, the overall tax burden has implications for how well minimum wages perform at supporting low-wage workers, while avoiding significant job losses.
Given the overwhelming evidence in numerous economic studies, the Korean trade unions should have softened their stringent position and worked out an increase to their satisfaction. By boycotting the talks, they did not do justice to young people and low-skilled workers.
While it is impractical to do away with the minimum wage, given the social realities in Korea, the government should also step in and ease the concerns of businesses.
Some countries have adopted specific measures to reduce the gap between the amounts an employer pays and the take-home pay that the worker receives. To lower employers’ costs, or to reduce risks of employment losses following minimum hikes, some have introduced tax rebates for firms employing minimum wage workers ― something the Korean government should consider.
More importantly, there needs to be efficient coordination between minimum wage policies and other redistribution measures by the government, notably taxes and transfers ― that are lacking in Korea.
These small steps could go a long way in protecting the interests of businesses as well as ordinary workers, given that the economy is struggling to recover and unemployment continues to be a major concern.

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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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