Tag Archive | "economics"

Should South Korea Join the Transition to All Electric Vehicles?

By Troy Stangarone

The global automobile industry is on the verge of significant changes. Google, Uber, and traditional automobile manufacturers are pushing further into the development of autonomous vehicles and seeking to disrupt how vehicles are used by consumers. While the development of autonomous vehicles may change the way automobiles are used, they are not the only change that is likely to reshape the global automobile industry. Earlier this summer France and the United Kingdom announced that they will be phasing out combustion engines as part of a transition to only allow the sale of electric vehicles by 2040. China, the world’s largest automobile market, followed suit and announced that it was also planning to transition to electric vehicles in the future. While the moves by France and the United Kingdom are significant, the move by China could change the way South Korean policy makers need to think about automobile production and related issues.

In 2016, more than 23 million vehicles were sold in China, which is one of the top markets for Hyundai and Kia, accounting for more than a fifth of their global sales. If China follows through on its pledge to transition to electric vehicles, it will have a significant impact on the types of vehicles that Hyundai and Kia produce.

To date, the spread of electric vehicles has been held back by two issues. The first is what is commonly known as range anxiety. While the initial Tesla models average around 300 miles per charge, most electric vehicles on the market only get around a third of that distance on a single battery charge. With a limited infrastructure to charge electric vehicles consumers have been reluctant to purchase electric vehicles on a mass scale since they are limited in their usage compared to used gas powered vehicles.

The second issue is the ability of manufacturers to scale up demand and production to drive down costs so vehicles are price competitive with traditional combustion engines. Manufactures have tried to address this issue by introducing hybrid vehicles, increasing demand for the lithium ion batteries that power electric vehicles. This also addresses the range anxiety issue, and, in the case of Tesla, focuses on luxury vehicles where consumers are less price sensitive. At the same time, governments have offered subsidies to consumers to make electric vehicles price competitive.

The decisions by France, the UK, and especially China are already having an impact on the production decisions of major automotive producers. Under new regulations in China, automakers will be required to sell more vehicles that run on alternative fuels if they want to continue selling traditional vehicles. In response, global producers are looking to increase the production of electric vehicles in China, while in some cases shifting research and development to the Chinese market. GM and Ford have announced that they will be introducing 20 and 13 new electric vehicle lines over the next five years, respectively.

By mandating that all vehicles in the United Kingdom and France have electric engines, France, the UK, and eventually China are essentially working to address the scale issue by providing a guaranteed market for electric vehicles and signal to the private sector that it should continue to invest in the electric vehicle market. As the industry shifts toward electric vehicles, South Korea will need to consider the current state of the domestic market for electric vehicles, how market shifts abroad will affect the long-term competitiveness of Hyundai and Kia, the impact of the shift to electric vehicles on other South Korean industries, and how a shift to the mass usage of electric vehicles would impact the energy market in South Korea.

The Role of Electric Vehicles in the South Korean Market

The market for electric vehicles in South Korea is still embryonic. In 2016, only 5,914 electric vehicles were sold in South Korea, a market of 1.54 million vehicles. In contrast, 352,000 electric vehicles were sold in China last year and 159,139 were sold in the United States.

As other markets shift, the development of electric vehicles and their adoption in the South Korean market will increasingly become a competitiveness issues for the South Korean auto industry. While Hyundai and Kia have begun producing electric vehicles, they trail U.S. producers such as Tesla and GM, as well as Chinese firms which have dominated the market in China, where Tesla is the only foreign company to have had success.

While South Korea is behind the curve in the area of electric vehicles, the government has taken steps to promote the adoption of the technology through the development of the necessary recharging infrastructure and by providing purchase subsidies. The goal is to have ecofriendly vehicles account for 30 percent of sales in three years, up from 3 percent today. The question is will those steps be enough to jumpstart the industry in South Korea or should South Korea institute a mandate for electric vehicles similar to France and the United Kingdom?

The Battery Industry and Electric Vehicles

The potential future of South Korean auto industry isn’t the only other industry at stake in the shift to electric vehicles. In 20 years, the shift to electric vehicles is expected to create a $240 billion market for batteries. At the moment, LG Chem and Samsung SDI, are two of the leaders in battery market for electric vehicles, with LG Chem supplying the batteries for the Chevy Volt hybrid and Chevy Bolt electric vehicle. However, China hopes to claim this market for its own domestic producers, much as it has done in emerging energy industries such as wind and solar power, by driving down prices and restricting foreign competition. It has also refrained from certifying Samsung SDI and LG Chem vehicle batteries in China, limiting their ability to grow in the world’s largest electric vehicle market.

The Future of Energy Production in South Korea

The shift to electric vehicles is not only about production and the potential export industries it would affect, but also about the supply of power to charge a growing fleet of electric vehicles. Shortly after assuming office, President Moon Jae-in announced that he planned on phasing out coal and nuclear power plants and replacing them with new LNG plants and renewable energy. A commission established to study the issue has recommended pushing forward with plants already under construction, but has also suggested scaling back nuclear power in the long-term.

While the plan was put forward to address public concerns over air pollution, it could impact South Korea’s ability to transition to electric vehicles. While burning LNG is cleaner than coal, there are already concerns that the shift away from coal and nuclear power could lead to power shortages. A significant shift to electric vehicles would require an increase in electrical production and a movement away from nuclear power could reduce any of the benefits of zero emissions from electric vehicles or constrain their growth if South Korea faces power constraints in the future.

The actions by France, the UK, and China have the potential to reshape the global automobile industry. For a country such as South Korea, this has significant implications for the future of automobile production, but also larger sections of the South Korean economy. As a result, South Korean policy makers will need to consider how these shifts will impact not just the domestic auto industry, but how the shift will impact other industrial sectors, along with power generation in South Korea. The policy decisions made now could help to ensure that South Korea maintains a competitive automobile industry and develops the new technologies of the future.

Troy Stangarone is the Senior Director for Congressional Affairs at the Korea Economic Institute of America. The views expressed here are the author’s alone.

Photo from the National Renewable Energy Lab’s photostream on flickr Creative Commons.

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Why Is There No UberX in Seoul?

By Hayeon Carol Park

On September 21st, Uber Technologies, Inc. launched UberSHARE, a car pool service in South Korea, just a month after it launched the restaurant delivery app UberEATS. The successful launch of these services raise an important question: why is UberX still not offered in South Korea? The answer is simple – the South Korean government has banned UberX from operating in Seoul. However, there are market based incentives that should help convince Seoul to allow UberX to operate.

Uber has been attempting to enter the Seoul market since as early as 2013, but it was outlawed by the South Korean government in 2014. After a series of lawsuits and trials, the Seoul Central District Court ruled that Uber was violating Korea’s Passenger Transport Service Act by illegally using non-licensed private vehicles for commercial purpose. Uber was fined 10 million won ($8,840) for running an illegal business and was forced to stop operating. While looking for an opportunity to resume the UberX business in Seoul, Uber launched its premium taxi service, UberBLACK, last year. Once again, the Seoul government stepped in to limit UberBlack’s service through unusual regulations that allow UberX services to be provided only to foreigners, the disabled, or government officials.

Although Uber Technologies faced serious legal setbacks within the U.S., the opposition from South Korea, and many other foreign countries for that matter, reveals protectionist attitudes against foreign competitors. In London, Uber was recently banned by the local governing body, Transport for London, for not following local laws, which raises suspicions that the ban was a move to protect the existing local taxi apps such as Gett and Mytaxi. Similar suspicions can be raised for Korea – South Korea’s development paradigm during the 1960’s and 1970’s was founded on tight cooperation between industry and government, wherein the Korean government provided an appropriate incubation environment for the Korean companies by limiting foreign competitors from entering the market.

As such, the South Korean government outlawing Uber in Korea can only be discussed in the context of supporting KakaoTaxi. Daum Kakao, the maker of South Korea’s most popular messaging app, launched KakaoTaxi in Korea in March 2015, but it is not as innovative as Uber. Uber is a real-time ride-sharing technology, while KakaoTaxi is simply an app used to order regular taxis. KakaoTaxi has not only signed an agreement with the mostly government-owned subway card maker Korea Smart Card Corp., but it also partnered with the Korean National Joint Conference of Taxi Association, the Seoul Taxi Association, and the Federation of Korean Taxi Workers’ Union.

When Uber was trying to expand its services in Seoul, the Seoul government was faced with immense pressure from the taxi unions, known to have huge lobbying power in Korea. In response, the Korean government began cracking down on Uber drivers by even offering a reward of 1 million won to Koreans that notified them if they ever saw an Uber driver. “I cannot see how this ordinance serves the interests of Seoul citizens. It leads us to question that the City’s officials are bowing to pressure from taxi associations, which have declared war on competitors,” said Allen Penn, head of Asia operations for Uber. By the time UberBLACK launched in Seoul, the government had already ensured that KakaoTaxi had cemented its market dominance.

Korean taxi drivers feel threatened by Uber and perhaps understand that customers are unhappy with traditional taxi services. Taxi drivers around the world are shielded from competition and therefore become lax enough to offer poor service at inflated prices. On the other hand, Uber operates efficiently without traditional barriers for entry. While the Uber drivers do have to pass basic background checks, they do not have to obtain $1 million dollar medallions as in New York City, for example, to operate.

Allowing Uber to compete with KakaoTaxi will not only improve people’s lives with more consumer choice, but also improve the quality of the existing taxi services in Seoul. If UberX was in Seoul, regular taxi drivers would have no choice but to innovate and improve their services in order avoid becoming outdated and losing market share. In my experience, Korean taxi drivers tend to drive recklessly, swear in bad traffic, and provide bad service. On the other hand, Uber drivers have an incentive to drive safely and provide quality service, as they need to maintain high rating in order to stay in the market. Regular Korean taxi drivers would have no choice but to emulate this behavior in the marketplace.

The government’s decision to ban Uber may have particularly significant consequences if it harmed Korea’s reputation as a capital of futuristic high tech business. Seoul mayor Park Won-soon has claimed he wants to make South Korea’s capital a global role model for the sharing economy, but he is opposing a company that helped launched this global phenomena. If South Korea continues to push back against the concept of the sharing economy while the rest of the world is gradually becoming Uberized, it will only be a matter of time before Seoul is no longer a leader in digital technology.

Rather than yielding to the demands of the taxi drivers, the Korean government should remove onerous restrictions and allow Uber to operate in Korea while competing fairly with KakaoTaxi. Fortunately, the successful launch of the UberEats and UberPOOL signals that consumer demands are often strong enough to offset the regulatory forces. Despite this, more can be done to provide greater consumer freedom and flexibility for international businesses.

Hayeon Carol Park graduated from Yale University with a Master’s degree in International and Development Economics. The views expressed here are the author’s alone.

Photo from Automobile Italia’s photostream on flickr Creative Commons.

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Agreement to Renegotiate KORUS FTA Removes Threat of Withdrawal for the Moment

By Troy Stangarone

Shortly after the first summit meeting between Presidents Donald Trump and Moon Jae-in, the United States notified South Korea that it would like to convene a meeting of the Joint Committee under the U.S.-Korea FTA, or KORUS FTA, to discuss amending the agreement. Amending the KORUS FTA has been an objective of President Trump since last year’s presidential campaign and after the most recent meeting of the Joint Committee the United States and South Korea have agreed to renegotiations.

This will be the second time that the United States has pushed to renegotiate the KORUS FTA, which was originally signed in 2007 but not implemented until 2012. Much as was the case after the agreement was originally concluded in 2007, the new talks will likely focus on addressing issues in automotive trade.

Since coming into force, the United States trade deficit with South Korea has grown from $13.2 billion to $27.7 billion, but is down 28.1 percent through August. Over the same period, the United States trade deficit in the automotive sector has grown 77 percent to $24 billion and accounts for nearly 90 percent of the overall U.S. trade deficit with South Korea according to USTR.

While the automotive sector will be one of the key issues in talks, other issues that could potentially be discussed include implementation issues or revisions related to legal services, agricultural tariffs, data localization, digital trade, rules of origin and investment protections. While not all issues will apply, the ongoing talks over NAFTA also provide a good guide to the administration’s potential goals. At the same time, we should also expect South Korea to develop a list of areas where it would like to see changes that would be favorable to it as well.

Before entering into formal talks to amend the FTA, South Korea will need to undergo domestic consultation procedures including conducting an economic feasibility study, public hearings, and making a report to the National Assembly. As long as any South Korean requests do not require changes to U.S. law, the United States will be able to conduct the negotiations without utilizing the procedures under Trade Promotion Authority and already has authority to make any tariff changes agreed to with South Korea.

Additionally, with the agreement to renegotiate the KORUS FTA, the United States threat to withdraw from the agreement should further recede into the background. At today’s Senate Finance Committee confirmation hearing, Jeffrey Gerrish, nominee for Deputy USTR for Asia, and Gregory Doud, nominee for Chief Agriculture Negotiator, both noted that the administration should do no harm to existing FTAs. But the threat could still resurface as in the NAFTA talks where President Trump mused after renegotiations began that he could still decide to withdraw from NAFTA. So, the prospect that the issue of withdrawing from KORUS could return at a future date.

However, the current security situation makes it imperative that the talks proceed smoothly and that the threat of withdraw is removed from the equation. As North Korea moves closer to completing its nuclear and missile programs, it will be increasingly important for the United States and South Korea to maintain close policy coordination and avoid issues that could create tensions in the alliance at a critical stage.

An improved KORUS FTA has the potential to benefit both the United States and South Korea. In the area of digital trade, well-known companies such as Facebook and Youtube were only just establishing themselves and updating the agreement to reflect modern trade patterns should be mutually beneficial. The key is to find ways to enhance the agreement rather and avoid disputes that create tensions in the alliance.

Troy Stangarone is the Senior Director for Congressional Affairs at the Korea Economic Institute of America. The views expressed here are the author’s alone.

Photo from Natig Sharifov’s photostream on flickr Creative Commons.

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Moon Jae-in Takes a Different Path to Change in South Korea

By Hwan Kang

When Moon Jae-in was elected after former President Park Geun-hye was impeached, Koreans expected major policy makeovers. Indeed, the Moon Administration is trying to meet expectations by addressing some of Korea’s long lasting problems by announcing progressive measures such as an increase in the minimum wage and regulating the real estate market. However, Moon is also showing he is different from other politicians not by tearing apart Park Geun-hye’s legacy entirely, as some other progressive politicians have promised, but rather by utilizing part of it to his advantage.

One of former President Park’s main priorities was her “Creative Economy” plan, which aimed to promote economic growth and create jobs by fostering imagination, creativity and technology. This was the basis for hosting many startup contests and funding new startup centers that were supposed to inspire young minds to create new businesses. However, not only did the “Creative Economy” turn out to be a major flop with no definite results, it became a center of many embezzlement and bribery allegations in relation to Choi Soon-sil and her co-conspirators. The scandal also left the Korean public with a very bad impression of startups, causing many startup centers to face funding cuts and endangering new ventures.

In his 5-year policy roadmap, which was announced last July, Moon promised to continue the governmental support for startups despite the bad publicity, while promising a thorough investigation into allegations against the previous administration. He is planning to revamp government support for startups to boost the economy and create jobs in preparation for the “4th industrial revolution.” He even showed that he is going to prioritize startups by changing the name of the ministry charged with handling small business issues from the “Ministry of SMEs” to the “Ministry of SMEs and Startups (MSS).” The words may have changed, but the core startup policy remains pretty much the same as the “Creative Economy.”

Similar to Google or Paypal, it was startups such as Naver, Kakao, and numerous game companies that became surprising contenders against the chaebol conglomerates, always pushing the market to make way for new technology that the chaebols have overlooked. However, because the chaebols were so deeply rooted in the Korean market, SMEs and startups usually did not have a chance to grow into larger businesses themselves. Instead, they opted for big buyouts by the conglomerates, which in turn benefited huge companies even more. The reason the “Creative Economy” became a huge disappointment was that people thought it would finally be a big break for startups, many of which just want to continue developing what they have created. To those people who worried the new government would abandon the venture sector altogether, Moon’s plan may sound more refreshing than making any other changes.

Another policy that has remained steady through the transition between administrations has been the issue of the Terminal High-Altitude Aerial Defense (THAAD) system. Originally, the THAAD deployment created a significant amount of controversy, as it was pushed through by the Park administration without much open debate. It caused an uproar from South Koreans who believed there was some sort of sketchy arrangement behind the deployment because it happened to coincide with the Choi Soon-sil scandal. Additionally, concerns about possible electromagnetic wave pollution near the deployment site, on top of severe economic retaliation from China, also added to the growing anxiety. Each presidential candidate in the May election after Park’s impeachment put forward different positions on the deployment of THAAD, with progressive parties mostly leaning toward cancelling the plan.

Moon, who avoided giving a definite answer to the THAAD problem for a while, eventually decided to proceed with the “temporary deployment” this September and put an end to the indefinite delay. Just as could be expected, this decision was met with variety of mixed emotions from the South Korean public. Some from the progressive side, such as the Justice Party, criticized Moon for his apparent breach of trust, saying the Democratic Party had switched sides. According to Gallup Korea, the approval rate for the President took a slight hit, decreasing from near 80% to 70%, with his disapproval rate rising slightly as well after the announcement.

However, considering that the percentage of people who agreed to the deployment has remained steady within the range of 50%~57% dating from when Park announced the plan in July 2016, to two months into Moon administration in July 2017, one could guess that it was not the deployment itself that people wanted to change in general. Rather, their problem was with how the government handled the whole ordeal. This is a main point of contrast between Park and Moon – the former made little room for talk with the people while Moon at least took the time to consider an environmental test before making a decision. This becomes more evident when Gallup asked people what they thought about Moon’s decision to temporarily deploy four THAAD launchers –  72% replied it was the “right choice,” while 14% thought it was a “bad choice”.

South Koreans wanted change from the status quo and they picked the candidate who promised to deliver it, but the game is still far from over. Change can mean many things, from a complete reversal to minor alterations of existing policies. The Moon Administration is still in its early days and will need to decide what kind of changes would best benefit Korea. Koreans should also keep tabs on where the government is going so the country can head for the direction that people had intended when they impeached the last president.

Hwan Kang is currently an Intern at the Korea Economic Institute of America as part of the Asan Academy Fellowship Program. He is also a student of Seoul National University in South Korea. The views expressed here are the author’s alone.

Photo from the Republic of Korea’s photostream on flickr Creative Commons.

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The Hidden Costs of President Moon’s Minimum Wage Policy

By Hayeon Carol Park

In July 2017, South Korea’s Minimum Wage Commission finalized the decision to increase the country’s minimum wage by 16 percent to 7,530 won ($6.60) per hour in 2018. This minimum wage hike is seen as an early victory for President Moon Jae-in, who has pledged to be a “jobs president” by raising the minimum wage to 10,000 ($8.80) won by 2020. Ironically, in the weeks following the decision, Gallup Korea’s survey of 1,012 adults across the country showed that President Moon’s approval rating dropped by 6 percentage points. Such a dramatic increase in minimum wages, the biggest since 2001, may have played a prominent role in reducing President Moon’s popularity. Further, as some experts and small business owners argue, sudden minimum wage hikes can negatively impact Korea’s economy.

President Moon pushed for a steep increase in the minimum wage as a key ingredient of his income-led growth policy. In contrast to his two predecessors, who argued that businesses must grow first for jobs to be created, President Moon assumes that rising income and boosting consumption can bring growth and lift people out of poverty. To meet Moon’s 10,000 won goal, the minimum wage needs to keep increasing by about 15 percent annually, compared with an average of 7.4 percent over the last five years. But according to Dr. Bong Young-Shik from Yonsei University, increasing labor costs that quickly is sure to hurt small and medium-sized enterprises (SMEs).

There are three main mechanisms that make such a quick minimum wage hike detrimental to the Korean economy. First of all, it could trigger a higher unemployment rate. According to the Korea Federation of SMEs, additional labor costs are estimated to reach 81.5 trillion won if the minimum wage rises to 10,000 won. Going further, a 2016 study of Korea’s labor market by Lee Jung-min, professor of economics at Seoul National University, predicts that a 0.1 percentage point increase in the minimum wage would result in a 0.15 percentage point reduction in jobs, due to lower profitability and lay-offs. As such, the net wages earned by workers in the Korean economy is projected to begin falling when minimum wage rise exceeds 10 percent. This prediction is exacerbated by the fact that most minimum wage employees tend to work at SMEs, including family-owned convenience stores and coffee shops.

Secondly, a minimum wage hike can contribute to South Korea’s fiscal deficit. The finance ministry proved this point when it announced its plan to spend $2.66 billion to assist any SMEs that are negatively affected by the new wage policy. In addition, higher unemployment due to the closure of smaller businesses will compel more people to rely on government handouts. “[This plan] would obviously come at a high financial cost that would bring Korea deep into a fiscal deficit and add to the public debt that has doubled to nearly 40 percent since 2000,” said Hosuk Lee-Makiyama, a director at the European Centre for International Political Economy. Furthermore, the 2016 OECD study of South Korea recommended that instead of providing large subsidies to the SMEs, the Korean government should encourage the SMEs to compete and innovate.

The third issue with the plan involves the potential polarization of the economy. Dr. Yoon Chang-hyun, a professor of finance at the University of Seoul, worries that the higher minimum wage will induce further polarization of the labor market – narrowing the door to job-seekers while only bringing higher wages and security to the already employed. Businesses will also experience polarization. Large companies can absorb higher wage rates into their production costs and still maintain high enough profits. Smaller shops, on the other hand, will have no choice but to lay off workers or go out of business.

In the end, the economic costs of President Moon’s minimum wage policy must be compared to the corresponding social benefits. As this 2016 KEI blog on the minimum wage recognized, the wage level in Korea has not kept up with the rise of Seoul’s living costs, leaving many families unable to sustain a healthy lifestyle. These social dimensions must not be ignored. Hence, a balance must be found by recognizing that the minimum wage needs to be raised, but in a more cautious way that is carefully calculated to minimize the adverse effects.

Korean government data from 1988 and 2013 showed that annual growth rates were usually lower when the ratio of minimum wage to average income was higher. Based on this statistic, the pace of minimum wage increases should be adjusted slowly and with flexibility, taking into account variables like unemployment, prices, and living costs. In addition, policymakers should consider differentiating minimum wage levels among different industrial sectors of Korea’s economy or easing regulations for SMEs so that these businesses can thrive and afford to hire more workers. Exploring these options will hopefully bring us closer to finding a compromise between underpaid workers and profit-seeking SME owners.

Hayeon Carol Park graduated from Yale University with a Master’s degree in International and Development Economics. The views expressed here are the author’s alone.

Image from gorekun’s photostream on flickr Creative Commons.

 

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New Sanctions Aim at North Korean Economy, Less so Missiles and Nukes

Won hold steady as gasoline prices soar, but for how long?                                               

By William Brown

China and Russia watered down the new UN sanctions, imposed after North Korea startled the world with its apparent thermonuclear test September 3. However, their impact on the economy still could be severe, even crippling eventually.  By accepting tough rules on textiles, joint ventures, and overseas employment, both former communist capitals seem to have tossed out their previous, probably pretend, concerns for the well-being of the people and aimed squarely at the general economy.

Meanwhile, specific U.S. sponsored sanctions that would have disproportionately hit state enterprises and the government were denied, especially in the oil sector.  Kim Jong -un predictably reacted to the outside world with more bluster and yet another intermediate range missile test over Japan on September 14.  But we don’t know as much about what he and his circle of leaders are thinking and doing domestically, something probably of far greater importance.

One thing is for sure; big adjustments in economic policy are needed if he is to maintain progress on the two byongjin fronts—the nuclear program and economic growth. If he isn’t careful, inflation caused by commodity shortages will come roaring back to crack what remains of his command, or fixed-price economic system. This would undo what so far has been Kim’s crowning domestic achievement, getting a handle on a monetary system left in chaos by his father and grandfather (see byongjin blog).  As the leadership learned in a monetary panic in 2009, just as young Kim was being prepared to take over the government, nothing will bring people, even North Koreans, to the streets faster than an assault on their money. And if true nearly ten years ago, it is far more important today given the wide expansion in the use of money and markets that is contributing to economic growth.

If Kim needs any reminders of this predicament, all he needs to do is look down the street. Diplomats, and Daily NK reporters are saying the price of gasoline in Pyongyang has nearly doubled just in the past three weeks. A kilogram of gasoline is reported to cost W23,000 on September 9th, the equivalent of about $8 a gallon at the widely used black market exchange rate, up from W18,000 at the beginning of the month, W14,000 in late August, and 8,000 won in January.  Unlike a price jump in April, this time taxi and auto activity in Pyongyang is said to being impacted, and business is slowing.  Likely even more concerning to the government are similar jumps in diesel and kerosene prices, just as the important and fuel-intensive harvest season is beginning.  Diesel is widely used in portable generators providing essential electrical services in Pyongyang as the national grid supply remains unreliable. Complaints are bound to be rising, especially among the newly enriched entrepreneurial classes who need electrical generators to pump water for their high-rise apartments.

Petroleum though might be among the least of Pyongyang’s new concerns. The price jumps occurred despite what appears on paper very modest oil sanctions, suggesting prices may come down if the inflow is not actually squeezed.  The U.S. had hoped for an embargo of Chinese crude oil deliveries though few expected that would happen.  Instead crude oil will continue at its historic rate of about 4.4 million barrels a year (about 600,000 tons) and will likely remain free to the North Korean government based on a secretive Mao-era aid agreement. (I argue elsewhere that ending this aid is the key to pressuring Pyongyang.) Refined petroleum product sales to North Korea are capped at 2 million barrels a year, 500,000 barrels a quarter beginning in October, slightly less than the 2.2 million barrels China exported last year, but more than what China reports as having provided through July of this year.

Apparently, as reported by western news agencies, foreign exchange shortages are squeezing the North Korean importers so Chinese suppliers, such as the giant China National Petroleum Corporation, are withholding normal export credits, this was occurring even before the new sanctions.  If so, it may be that finance, rather than sanctions, will be the limiting factor on oil deliveries.  The U.S. government, on the other hand, asserts Pyongyang imports more than twice what North Korea’s trade partners admit to selling North Korea and that somehow all of this will be subjected to the 2-million-barrel a year cap.  This would mean that the total annual petroleum supply from all sources would fall from about 8 million barrels to about 6 million, a significant but not a drastic drop, and it would save Pyongyang precious foreign exchange.

Much more damaging to North Korea would be a collapse in the NK won, and attendant inflation, a logical outcome of the new embargos on North Korean textile and apparel exports and fish products.  According to Chinese customs, textiles have risen from almost nothing ten years ago to $330 million in the first seven months of this year. This is already down about 20 percent from the same period in 2016 and, if the sanctions are enforced, will drop to nothing in coming months. The foreign exchange cost to North Korea will be much less than that, since North Korea imports more textile related materials from China than it exports and much of these will no longer be needed.  Still, the disruption to the industry, one of the country’s largest employers, will be severe.  In recent years, textile factories have retooled to serve the export market and now will have switch back to a much less viable domestic market. Workers in the large, unproductive state factories will be generally unaffected but thousands, maybe tens of thousands of productive workers not in the socialist system will be forced out of their private or foreign joint venture workplaces. Many may try to go to China where factories will be in even greater need of cheap labor, but the new overseas employment restrictions will make that hard to do, at least legally.  How the regime responds to this soon to be hard-hit labor and export intensive industry should thus be watched very carefully.

This weekend diplomats in Pyongyang reported that about W8,000 will still buy a dollar in local exchange markets, no change from over the past few years, making the dollar price of gasoline among the highest in the world.  This stability is remarkable given the drop in exports, and indicated further drops on the way.  But here again North Korea, and its half-market, half-command economy is anything but normal.  This stability is probably the result of extreme caution in providing new credit, effectively preventing new investments, or wage increases for impoverished state workers, and in allowing foreign currency, U.S. dollars, to invade the economy at all levels. Pyongyang may even be intervening in the new foreign exchange markets to support the won, expending precious dollars to do so.  North Korea, quite amazingly, thus seems on its way to becoming a dollarized or currency board type economy, one in which the government has little control over the money supply, the banking system, and even its own budget.  If North Koreans are like people the world over, and there is no reason to think they are not, once a small break in the value of won occurs, they will panic and sell their won for available dollars in a downward, self-realizing, spiral.  The government knows this and is valiantly holding the line.

Sooner or later we can expect the rate to crack, just like ancient Korean houses  in Ryanggang province reacting to the September thermonuclear explosion. How then will the young Marshal respond?

William Brown is an Adjunct Professor at the Georgetown University School of Foreign Service and a Non-Resident Fellow at the Korea Economic Institute of America. He is retired from the federal government. The views expressed here are the author’s alone.

Photo from Roman Harak’s photostream on flickr Creative Commons.

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Growing Role of FDI from Korea in Providing Opportunity and High-Paying Jobs for America

By Phil Eskeland

Recently, the U.S. Department of Commerce updated their statistics on the role of foreign direct investment (FDI) in the United States.  The United States is still home to the largest amount of FDI in the world.

South Korea continues to demonstrate its confidence in America by once again in 2016 increasing its holdings of $38.8 billion in investments at U.S.-based companies, nearly double the level the year prior to the implementation of the Korea-U.S. Free Trade Agreement (KORUS FTA) in 2011.

These are investments found in many states around America, including struggling communities in rural America that have clamored for economic opportunity and development.  Many investments have come from familiar, well-known Korean nameplates, such as Hyundai, KIA, Samsung, and LG.   But others may not be as well known.  For example, Doosan invested $4.9 billion to purchase Bobcat, a manufacturer of small construction and machinery equipment based in North Dakota, during a downturn in the U.S. home construction sector in 2007.  Last May, Doosan Bobcat North America completed a $9.5 million expansion of its headquarters, reflecting confidence in its future growth as a major manufacturer and employer in the Upper Midwest.

South Korea’s investments are heavily focused on the manufacturing sector, with automobile components and equipment; industrial machinery; and consumer electronics as top sectors, along with software and information technology services.  Many of the software and IT service companies are small firms, such as IriTech in Fairfax, Virginia that creates biometric identification software.

In addition to the growing level of investment, the number of Americans working at U.S.-based firms with investment from Korea has increased by over 50 percent since 2011 to employ 54,800 individuals in 2015.

These worker’s average annual compensation has grown 11 percent in the years since KORUS to approximately $91,100 in 2015.  This is remarkable in light of the average compensation level of workers at all companies with FDI ($79,328) and the U.S. median household income ($57,230).  In other words, a typical U.S. worker employed at a U.S. firm with investment from Korea earns nearly 60 percent more than a worker elsewhere in the U.S. economy and even 15 percent more than his or her counterpart employed at other U.S. firms with FDI.

Lastly, these firms helped to augment U.S. exports by $14.2 billion in 2015 and invested $1 billion in research and development.  Suffice it to say that if there was no investments by Korean firms in the United States, the trade deficit would have been even higher and perhaps some cutting-edge, innovative product would not be in the marketplace producing more economic growth and opportunity for American workers.

Thus, as the discussions on the future of the Korea-U.S. Free Trade Agreement (KORUS FTA) proceed or as other actions on trade or tax policy are contemplated, policymakers should do no harm to cultivating a positive climate for more FDI from South Korea.

Phil Eskeland is Executive Director for Operations and Policy at the Korea Economic Institute of America. The views expressed here are his own.

Photo from raymondclarkeimages’ photostream on flickr Creative Commons.

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Korean AI Market Competition Heats Up

By Hwan Kang

Elon Musk tweeted last August that AI (Artificial Intelligence) has “vastly more risk than North Korea.” So it may seem ironic to him that South Korean companies from different industries are so eager to apply AI into their services amid the ongoing missile fiasco in the North.

Major IT companies such as Naver and Kakao have announced throughout the year that the next main focal point in their businesses would be developing their own AI that can process deep learning and provide better services to the users. Naver has boasted about its devotion to AI development by acquiring Xerox Research Center Europe (now Naver Labs Europe), a leading lab in intelligence research, and aggressively investing in startups that can develop different facets of the deep learning process. On the other hand, Kakao has announced that its new subsidiary for AI research, Kakao Brain, will be personally spearheaded by Kim Beom-Soo, the visionary billionaire who founded KakaoTalk. Its plan is to catch up to the level of other leading research centers by actively recruiting developers with specialties in search patterns and natural spoken Korean.

The first tangible result from the competition in the Korean AI market is the AI speaker. Koreans are excited about the upcoming launch of AI speakers from both tech companies, who promise intelligent assistance that will integrate deeply into customers’ daily lives. These AI speakers will provide easy access to the makers’ various services through voice commands that support spoken Korean and English.

Last August, Naver got a head start on its competition when it unveiled its brand new AI speaker, “WAVE”. The speaker was met with great enthusiasm, selling its entire stock in Korea in just 35 minutes and closing pre-orders in Japan after just 5 days. WAVE uses “Clova,” Naver’s AI platform, as its operating system, and provides convenient services with smart responses. Notable functions include English speaking mode for English learners and Japanese/Chinese translation.

Kakao is also looking forward to launching its own brand of AI speakers called “Kakao Mini” later this year. Not much has been revealed about the product yet, with the website only providing a sneak peek. However, people are anticipating the speaker’s release because it’s AI program, “I”, is expected to be connected to popular Kakao services such as KakaoTalk messenger and Melon’s music app.

More intangible AI results have also been revealed to the public throughout 2017. One example is “Naver Smart Lens”, a visual AI service that can recognize letters, QR codes, and various other images. The “AiTems” system in Naver’s mobile shopping app can analyze preferences from the users’ search history and suggest certain items, even if they have not used the service before. Naver Labs has also participated in the Seoul Motor Show and announced its plans to use deep learning for autonomous cars that can use the system to learn how to detect and avoid traffic. Kakao has similarly announced its bold plan to create a “Smart Home” and apply its AI into new apartments that are under construction. It is collaborating with major construction companies such as GS and Posco to initiate its plan.

The two companies are not the only major players in the Korean AI market, though. Banks and credit card companies have emerged as participants in the market as well. Banks such as KEBHana and Woori have collaborated with telecommunication companies SKT and KT respectively to develop ChatBots. ChatBots will be able to do banking transactions and provide necessary information based on consumers’ behavior patterns. They are expected to advance non-face-to-face banking services even further. Similarly, Hyundai Card has created its own ChatBot, “Buddy,” based on IBM Watson’s natural language processing system. Jung Tae-Young, the CEO of the company, has shown his high expectations for the AI on his Facebook account, saying it will grow up and show different attitudes.

South Korea Ministry of National Defense is also considering applying AI into the country’s defense system, according to its New Year resolution for 2017. It has announced it will consider integrating AI into its cyber defenses against North Korea. In fact, the South Korean military already has something similar to AI in place. The South Korean Army has so-called “killer robots” deployed in the DMZ that work as unblinking eyes on the 38th parallel. The robots are called SGR-A1, developed by Samsung Techwin (now Hanhwa Techwin). They are considered one of the earliest autonomous robot defense systems, along with Israel’s system. Its specifications list a machine gun and grenade launcher as the robot’s primary weapons, and it is equipped with heat and motion detectors that can track down enemies without assistance from humans. They can also use a security clearance procedure with an instant shoot to kill process, but is not activated due to concerns of confusing civilians from enemies. Instead, the bots send signals back to the central base and wait for further command.

Such efforts in Korea to develop and integrate AI into various areas have many economic implications. Korean companies still lack capabilities to compete in the global market. Developing AI is therefore the smart thing to do during the so-called 4th industrial revolution, especially ones that can understand naturally spoken Korean better than their foreign counterparts.

However, Korean companies may not have the advantage of “fast followers.” According to a report from IBK Economic Institute, Korean AI products have nothing to gain from market leaders’ trial and error process because AI is so complicated and inherently closed to outside competitors. Also, since the leaders had the advantage of cornering the market on AI technology, they have had more time to reach the necessary customer base for the system to develop enough sentience, which means the market followers will have to work with the leftover margins. As a result, the major developers with more resources will have continued dominance over the AI market, which is already evident as in the cases of Apple (Siri), Amazon (Alexa) and IBM (Watson). IBM Korea has recently announced that Watson can now understand spoken Korean, so time for Korean AIs is running out fast.

Another implication has to do with an AI’s moral compass. AI programs do not have moral obligations to work for the collective good of society, but they can work to maximize a company’s profits. This means that AIs can become tools to subtly but efficiently empower companies in the market. There are already cases where pricing algorithms have been used to develop a perfect price differentiation scheme or form an indirect price cartel. The case of Dutch gas stations is an important example – different gas stations constantly changing prices in accordance with customer’s predictive needs for gas under different conditions. This was possible thanks to a “dynamic pricing” program that refreshes prices based on real time market data. What was worse was that because different gas stations used the same algorithm, it was impossible for the customers to avoid the price differentiation wherever they went, effectively forming a price cartel that maximized the company’s interest. There is no guarantee that this will not happen in Korea once AIs are set in place everywhere people go.

The vast opportunities for AI both in Korea and around the world, along with the concerns that go along with those opportunities, show clearly that we may be reaching a turning point where many conventional economic norms could change, especially for tech-savvy South Koreans.

Hwan Kang is currently an Intern at the Korea Economic Institute of America as part of the Asan Academy Fellowship Program. He is also a student of Seoul National University in South Korea. The views expressed here are the author’s alone.

Image created by Jenna Gibson, Communications Director, at the Korea Economic Institute of America from a photo by Nick Amoscato on flickr Creative Commons.

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No Reason to Withdraw from the KORUS FTA

By Phil Eskeland

Rumors flooded Washington over the Labor Day holiday weekend that the U.S. would soon withdraw from the Korea-U.S. Free Trade Agreement (KORUS FTA).  When President Donald Trump visited hurricane-damaged Houston, Texas on Saturday, he was asked by reporters about this development and responded that he would discuss the fate of KORUS with his advisers this week.

The White House may have delayed a decision on withdrawal from the agreement until the publication of the most updated monthly trade statistical information from the Foreign Trade Division of the U.S. Census Bureau at the Department of Commerce.  Earlier this morning, this data was released to reveal two interesting points.

First, while U.S. exports of merchandise goods to the Republic of Korea (ROK) in July fell by a modest 3.7 percent as compared to June, the level was 16 percent higher than July 2016.   As a result, the Year to Date (YTD) merchandise trade deficit between the U.S. and South Korea still remains well below last year’s level.  Thus far, the YTD (January – July) merchandise trade deficit between the U.S. and South Korea is $13.1 billion (vs. $18.8 billion in 2016), representing a 30 percent decrease.  If present trends continue, the trade imbalance in goods alone would drop below $20 billion for 2017.

Second, when adding in trade in services, the latest release illustrates a more complete picture.   As part of this morning’s release, 2017 2nd Quarter services data was also made public.  Once again, it shows a modest, but steady increase in U.S. services exports to Korea during the previous four quarters.  As a result, the YTD (January – June, 2017) bilateral trade imbalance of both goods and services between the U.S. and the ROK showed a decline of 50 percent (or half) when compared against a similar time period in 2016.

For the 1st and 2nd Quarters in 2016, the bilateral U.S.-ROK trade deficit of goods and services was $10.6 billion.  However, for the 1st and 2nd Quarters in 2017, the good and services trade deficit between the U.S. and South Korea dropped to just $5.25 billion, in part, because of the amazingly low goods and services deficit level of $1.5 billion for the 2nd Quarter (April – June) 2017.

For all of 2016, the U.S.-South Korea goods and services trade imbalance was $17.6 billion, representing one of the smaller deficits with any of America’s major trading partners.  If this trend continues, the U.S.-ROK combined goods and services trade deficit could be $9 billion or less for 2017, which represents near balance.

Now is exactly the wrong time to terminate the KORUS FTA.  Various tariff and non-tariff barriers to U.S. products would go up reversing the recent, hard-won progress made to lowering the trade imbalance between the U.S. and South Korea, which is one of the main goals of President Trump.  If improvements can be made to the agreement to further open markets, U.S. and Korean negotiators should take advantage of the opportunity to lock in these revisions irrespective of the possible effect on the trade imbalance.  However, a whole-scale rejection of the agreement would be unwise and counterproductive to advancing the goals of creating more prospects for U.S. exporters to sell in South Korea because tariffs (or import taxes) would snap-back to higher, pre-KORUS FTA levels, making U.S. products more expensive in Korea, particularly in relation to other foreign competitors that have a FTA with the ROK.

Phil Eskeland is Executive Director for Operations and Policy at the Korea Economic Institute of America. The views expressed here are his own.

Photo from Diego Cambiaso’s photostream on flickr Creative Commons.

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Borkers at the São Paulo Stock Exchange (Bovespa).

Provoking the Market: Investors More Worried about Washington’s Response than Pyongyang’s Provocations

By Kyle Ferrier

Analysts have attributed recent market downturns to North Korean provocations, but investors seem to be reacting more negatively to responses from the Trump administration.

Prior to North Korea’s sixth nuclear test on Sunday, Kim Jong-un was cited as a key contributor to recent developments in global markets. The fall in the value of the dollar and the strengthening of the euro and gold this summer have at least been somewhat linked to North Korean provocations. For the dollar and the euro, North Korea is at most exacerbating these trends, not causing them. Since the end of last year, the dollar has been in general decline and the value of the euro has steadily grown. This is primarily driven by looser monetary and fiscal policy in Europe as the Federal Reserve plans to unwind its balance sheet and the White House faces hurdles in its tax reform and infrastructure initiatives. It is harder, however, to argue Pyongyang has played an equally minor role in higher gold prices. Yet, movements in the price of gold and South Korea’s KOSPI stock index this year suggests investors are more concerned with uncertainty stemming from the Trump administration’s approach to North Korea.

Graph of the price of gold, March to September 2017

Graph of the price of gold, March to September 2017

The conventional wisdom has been that the financial impact of North Korean provocations in South Korea decreases over time. My analysis of North Korea’s nuclear tests, long-range rocket launches, and military provocations along the DMZ through February 2016 (after its second “satellite launch” attempt) found this line of thinking applied to nuclear tests, but could not fully explain the other two categories. It is more accurate to state that the impact of North Korean provocations on markets in Seoul depends on whether a given event is viewed to be outside the context of normal geopolitical developments. That the financial impact of North Korean provocations generally diminished merely illustrated investors had been through similar events and their bottom line was minimally affected. It was not necessarily an indicator of future reactions, particularly as circumstances surrounding each provocation can change dramatically.

KOSPI stock index, March to September 2017

KOSPI stock index, March to September 2017

Significant drops in the KOSPI corresponding with North Korean provocations in January and February last year raised concerns that markets were reacting to Pyongyang at levels not seen since the shelling of Yeonpyeong island in 2010, but these can be chalked up to coincidence rather than cause. These concerns were renewed later last year in the aftermath of North Korea’s fifth nuclear test on September 9. Many news outlets linked the 1.25 percent drop in the KOSPI that day to the test, but this was also coincidence and not cause. Of the 1.25 percent drop, only around 0.07 percent occurred after news first broke of the nuclear test at 9:45am. The fall in the KOSPI as well as the won was much more likely linked to Samsung’s Galaxy Note 7 woes as well as a slowdown in global markets. Thus, from 2010 through the end of 2016, North Korean provocations had a negligible impact on markets in Seoul.

The KOSPI’s reaction to the North’s latest nuclear test is the clearest indication that this trend has ended in 2017. On September 4, the first trading day after the test, the KOSPI opened 1.73 percent lower. Though some of these losses were gained back, it was down 1.19 percent by the end of trading. Unlike the previous test last year, the sixth nuclear test is most likely to blame for this drop. The only other instance of a notable drop in the KOSPI caused by a provocation was in response to the July 4 ICBM, though its impact was minimal: The KOSPI closed 0.58 percent lower that day and took five days to recover. The ICBM launch on July 28 saw almost no change in the KOSPI or the value of the won. And, the August 29 ballistic missile that flew over Japan was only met with a 0.23 drop, which was made back the next day.

Timeline of North Korea's rocket launches and their impact on the South Korean KOSPI stock index

Timeline of North Korea’s rocket launches and their impact on the South Korean KOSPI stock index.

That markets would react to the earlier ICBM launch and the nuclear test makes a degree of sense, considering that both added a new component of geopolitical risk on the Korean Peninsula. The July 4 missile launch was the first time Pyongyang demonstrated its capability of hitting a U.S. state and the nuclear test also possibly revealed its ability to miniaturize a nuclear weapon.

However, from stronger market responses to the Trump administration’s approach towards Kim Jong-un, it is highly likely that Washington is playing a greater role in the negative market reactions to Pyongyang this year. From April 4 to 11, the height of confusion over the whereabouts of the USS Carl Vinson, the KOSPI fell six straight days, totaling to a 2 percent loss. From August 8 to 11, after Trump’s “fire and fury” comments, it fell four consecutive days, amounting to more than a 3 percent loss. “Fire and fury” was also a retort to the July 28 ICBM launch, which ironically had no discernible financial impact in Seoul.

Table of North Korea's nuclear tests and their impact on South Korea's KOSPI stock index

Table of North Korea’s nuclear tests and their impact on South Korea’s KOSPI stock index.

Both incidents also had a bigger impact on the price of gold than did North Korean provocations.  Between April 3 to 13 the price of gold shot up 2.75 percent. It rose again by 2.5 percent from August 8 to 11. Market responses to the provocations in July were mere blips by comparison. Gold rose a quarter percent on July 4, but was back to its previous price within two days, and the price actually fell after the subsequent ICBM launch. Though the August 29 and September 3 provocations were met with steep price increases – 2 percent and 0.68 percent, respectively – these reactions seem to be heavily influenced by Trump’s “fire and fury” comments, evidenced by the current increase in gold prices starting around the time of his remarks.

While harder to judge from the KOPSI alone, the comparison with gold prices implies that this week’s drop in the KOSPI was a product of market nervousness about how the U.S. might reply to the test, not North Korea. Further, if geopolitical concerns did play a role in the KOSPI in early July, they were likely caused by anxieties about a U.S. response, fueled by the USS Carl Vinson incident and Trump’s “disruptive” foreign policy.

Although these reactions are relatively minor and fleeting in the grand scheme of markets, they provide a window into how investors view geopolitical developments on the Korean Peninsula. They may only reflect temporary sentiments, but present the strongest case there has been in recent years that Washington is perceived as the primary driver of risk on the peninsula, not Pyongyang.

Kyle Ferrier is the Director of Academic Affairs and Research at the Korea Economic Institute of America. The views expressed here are the author’s alone. 

Photo from the Rafael Matsunaga’s photostream on flickr Creative Commons.

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About The Peninsula

The Peninsula blog is a project of the Korea Economic Institute. It is designed to provide a wide ranging forum for discussion of the foreign policy, economic, and social issues that impact the Korean peninsula. The views expressed on The Peninsula are those of the authors alone, and should not be taken to represent the views of either the editors or the Korea Economic Institute. For questions, comments, or to submit a post to The Peninsula, please contact us at ts@keia.org.