Koreas Economy 2005

a publication of the Korea Economic Institute and the Korea Institute of International Economic Policy

Volume 21

CONTENTS

Part I: Overview and Macroeconomic Issues Economic Outlook for Korea in 2005 Huh Chan-guk . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1

Part IV: External Issues U.S.-Korea Economic Relations View from Washington Nan N. Fife. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .29 View from Seoul Ji Hye-yang . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 38 Koreas Trade and Direct Investment Christine Brown . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 43 The Yellow Sea Economic Basin Pietro Doran . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 48

Part II: Financial Institutions and Markets The Post-Crisis Transformation of Koreas Banking System Thomas Byrne . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9 Prospects for Developing Koreas Financial Market Jeon Jong-gyu . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13

Part III: Structural Reform Responses to Financial and Economic Distress in Korea and Japan Thomas Cargill and Hugh Patrick . . . . . . . . . . . . . . . . . . 17 New Frontiers of Financial Reform in Korea Kwon Jae-joong . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23

Part V: North Koreas Economic Development and External Relations North Koreas International Economic Relations: Trends and Future Prospects Oh Seong-yul . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 55

YELLOW SEA ECONOMIC BASIN: THE RISING DRAGON OF ASIA

by Pietro A. Doran

A timeless sea echoing of powerful empires come and gone; of heroic battles waged, won or lost; of great cultures dominating in their time now just memories or rendered shapeless in the shadows of legend and story; of exotic ports and rich cities, some long forgotten and teeming with ghosts, and others resurgent and full of life; of tragedy and glory; of war and peace. A sea whose tides in a timeless rhythm faithfully marked the passage of history and impeded no travelers from their charted course was then locked behind a wall of ideological conflict and war, slowly fading from the collective international consciousness. A sea that now, inevitably, boils like an economic cauldron, breaches the man-made divide, and rises again like a mighty dragon to claim its rightful place within the world arena. And where is this dragon sea? Is it the timeless and mythical Mediterranean or the voluptuously exotic South China Sea? Is it the Caspian with its Persian legends or the Arabian Sea with its tales of conquest, science, and religion? It is none of these. Instead it is our own Yellow Sea, nearly forgotten over the past 60 years owing to war, politics, and ideological conflict. And the lands that bound this fabled sea are already caught up in the relentless tides of political change that are even now forging a new economic paradigm for peace, prosperity, stability, power, and influence once nearly impossible to imagine. What Is the Yellow Sea Economic Basin? From a distance, the regions bordering the rim of the Yellow Sea are a matrix of separate countries that include China, Korea, and Japancountries that have long competed, fought, and intrigued with each other and with foreign powers for hegemony over the Yellow Sea. From a new perspective, a perspective made possible only through the tectonic changes of the past two decades, one gains a new understanding of the extraordinary changes occurring within what now is referred to as the Yellow Sea Economic Basin (YSEB), a region lying within 300 miles of the Yellow Sea rim

and encompassing Chinas Bohai region; the Korean peninsula; and Kyushu, Japan. Political and economic changes occurring within the YSEB during the past 20 years have driven an economic interdependence unthinkable, at least through peaceful means, only three decades ago. Dramatic changes in economic conditions within the YSEB have forced component countries to accept the thesis that the economic and political stability of each member is in the long-term interests of all. Each country has come to realize that achieving its own political and economic goals will necessarily depend on the ongoing stability of the entire YSEB. Playing the old game of one against the other is no longer a viable foreign policy. Adding to this new realpolitik are the facts that the worlds second-, sixth- (for now, in the case of China), and tenth-largest economies border the YSEB and that the worlds largest militaries are concentrated in the area of the YSEB. From these facts alone, one can see what the dragon truly representsthe economic, cultural, military, and political epicenter of Asia. The YSEBnot any one of its component membersis then itself the true North Asian hub. Like a corporeal being, the once individual parts of the dragon are now so interlinked that, when the head is sick, so is the body and so, immediately, is the tail affected. Areas of Chinas Economic Growth If this discussion is brought up to a broader level for a moment and if the concept of regional economic integration is taken to a wider perspective, one gets a new view of the economic order of China. It is increasingly evident that Chinas economic landscape depends primarily on two subeconomic zonesthe YSEB and the Pearl River Delta once dominated by Hong Kong but now an increasingly integrated megalopolis encompassing the cities of Guangzhou, Shenzhen, and Macau. Accounting for only 0.5 percent of Chinas land area, the very small, vital, and

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vibrant Pearl River Delta region constitutes nearly 33 percent of Chinas total exports and 10 percent of its total gross domestic product (GDP). Therefore, investors looking to participate in the explosive growth of North Asia no longer need think in terms of complex, far-flung markets but can focus instead on two concentrated trade zonesthe YSEB and the Pearl River Delta. If North Asia is reconceptualized in these terms, the contemplation of the logistics of trade within what appears at first to be an almost incomprehensible geographic area becomes far less onerous. Economic Structure of the Yellow Sea Economic Basin The new economic paradigm of the YSEB brings with it significant ramifications for each of the component countries that makes up the dragonin terms of their interrelationships; their individual relationships within the international community; and their own futures as uniquely independent, political, and cultural entities. An even more microeconomic view of the YSEB causes several critical facts to begin to emerge. Located within the YSEB are most of Asias greatest political and financial centers: Shanghai, Beijing, and Seoul; in addition, Tokyo is in close proximity to the YSEB rim. Demographically, no place in world exhibits so high a population density, with such concentrated economic growth in so condensed a region, as the YSEB. The YSEB, the rising dragon of Northeast Asia1 then becomes a subregional powerhouse with a population of more than 200 million who are changing and challenging the economic and political landscape of Asia. Already Northeast Asia makes up the majority of the population and produces more than 90 percent of the GDP of North Asia (Table 1). Through the heat of its economic expansion, Northeast Asia now influences and challenges the current world economic order. The dynamics of the dragon then become an agent of hope for many, a concern for some, and an irresistible seduction for anyone involved in trade and investment. The component countries of the YSEB now swirling around each other through the gravitational pull of the Yellow Sea find themselves in an

evolutionary process that will determine the direction of their economies and, therefore, their people, well into the twenty-first century. Table 1: North Asia and Northeast Asia, Population and GDP, 2002
North Asia (China, South Korea, Japan) Population GDP 1,455,000,000 $5.9 trillion Northeast Asia (Chinas eastern coast, South Korea, Japan) 931,000,000 $5.4 trillion

Sources: China Data Online, http://chinadataonline.org/; World Bank, www.worldbank.org/data/quickreference/quickref.html.

Yellow Sea Economic Basin as a Regional Entity With this new perspective in play, one can now take a macroeconomic view and envision the YSEB as comprising not so much component countries but a region of megacities positioned around the dragon constellation like a sea of stars. These stars individually and collectively exert a powerful gravitational influence on each other such that they become interlinked through a universal fusion; whatever forces come to play in one will naturally stir and attract the forces of the other. This new view does not argue, nor does it attempt to present, a case for political union but, instead, predicts an eventual regional integration among the component YSEB economies along the lines of the North American Free Trade Area. The implications of this process for the YSEB countries and the world are immense. Within the YSEB like pearls of a necklace around the Yellow Sea are more than 60 megacities, each boasting a population of more than one million (Figure 1). Counted among these cities are some of the worlds fastest-growing and increasingly influential financial and political megalopolises, including the fabled Shanghai (with a population of 13.3 million); the broodingly powerful political center of China, Beijing (population

1. In this paper, Northeast Asia comprises Chinas east coastal area, South Korea, and Japan.

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9.8 million); and the ever ambitious and frenetically energetic city of Seoul (population 9.9 million), all lying just more than one hours flight from each other, all within one days shipping of each others major ports.

Figure 2: Koreas Trade with China, 2003, in percentages (by area)

Koreas exports to China
Hebei Lianoning Fujian Beijing Guandong Zhejiang Tianjin Jiangsu Shanghai Shandong Others

Koreas imports from China

Guandong Hebei Beijing Fujian Tianjin Zhejiang Shanghai Jiangsu Others Shandong

Lianoning

The YSEB is very important to its component countries. It is almost surprising that nearly 57 percent of Chinas total trade volume emanates from within the Yellow Sea. In 2003 (see Figure 2), Korea depended on the free flow of goods within the YSEB for 71 percent ($30.5 billion) of its exports to China (in Figure 2, the remainder of Koreas exports to China are divided between Guandong and the section labeled other; these are areas outside the YSEB) and nearly 67 percent ($13.4 billion) of its imports from China. Koreas most important exports to China are computers, mobile phones, and liquid crystal displays; and its major imports from China comprise solid fuels, metals, textiles, and electronic circuitry. The story of Kyushu island, that region of Japan lying within the YSEB, is the same. With an economy the size of the Netherlands and a population of more than 15 million, Kyushu and its two principal cities are heavily dependent on the YSEB for their economic well-being. For example, the city of Fukuoka depends on the YSEB for 16 percent of its exports and nearly 34 percent of its imports, while the city of Kitakyushu looks to the YSEB to absorb 27 percent of its exports and to provide nearly 50 percent of its imports. These

Source: Korea International Trade Association. Note: The sections labeled Guandong and Others represent non-YSEB areas. Fujian, Guandong, Hebei, Jiangsu, Lianoning, Shandong, and Zhehiang are provinces in China; Beijing, Tianjin, and Shanghai are cities in China.

numbers show the importance of the YSEB for continued stability throughout the region. In the current dialogue of media and industry, it is popular to talk about the various competitive advantages and disadvantages of one city within the YSEB over the other. One hears this in discussions concerning the hyperkinetic claims for hub status emanating from one component of the YSEB or another. It has become almost a tired clich that one city or region within the YSEB desires to achieve the status of a financial, information technology, biotech, logistical, and/or (sometimes all!) leisure hub of Northeast Asiaa fairly ambitious claim. This frenetic competition for such recognition (recognition by whom?) misses a vital point: the YSEB is not about competing economies. Instead, the YSEB is about taking advantage of complementary core competencies inherent in the region. Because distance from any one point to another in the YSEB is nearly meaningless, the significant variance in economic development exhibited within the region and the regions dense population

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concentration provide unmatched opportunities for efficiencies and opportunities in manufacturing, distribution, marketing, and trade. In a hypothetical case of an investors desire to establish a vertically integrated information technology base in the YSEB, these advantages become evident. Taking advantage of Koreas famously educated and highly skilled workforce, for example, a firm could establish a research and design facility within the city of Incheon. Then, taking advantage of low labor costs, the same firm could then locate manufacturing plants in places such as Kaesong, North Korea, or Dalian, China. This entire endeavor could be financed through a consortium that would include financial institutions in Shanghai, Seoul, and Beijing. Any problems of product design or production could be easily handled by a highly paid technician living in one of the increasingly cosmopolitan urban centers of the YSEB who could reach any destination within two hours of dispatch and still be home for dinner. Products could then be shipped to any point within the YSEB within one day (or within a few hours by air). A marketing team could then oversee the distribution of products throughout the region on daily visits to key markets located throughout the YSEB. By leveraging complementary advantages, not competitive disadvantages, the extraordinary market forces of the YSEB are unleashed. It is these internal mechanisms of trade, all depending on peace and stability within the YSEB, that are now driving the economic integration of the region. The YSEB as a regional year-round tourism market is still untapped and offers a vast diversity of geographical, historical, cultural, and environmental conditions all within the boundaries of the Yellow Sea. From the Great Wall of China to the ski slopes of Korea, from the cosmopolitan, crowded exoticness of Seoul and Shanghai to the semitropical islands that form the southern boundary of the YSEB, tourism sites abound. The YSEB touristincreasingly a citizen of the YSEBenjoys a plethora of world-class golf courses in just about every kind of terrain and climate imaginable, and all are reachable within two hours or less by air or barely a day by luxury ship from any point on the Yellow Sea rim. It is exactly this variety of industry and lifestyle opportunities that in the past has attracted people from around the world to live and work in Hong Kong and Singapore. The tourism industry,

through travel and communication networks, then becomes a vehicle vital to YSEB regional stability. Regional Problems North Korea The black hole of the YSEB universe is North Korea. Investors around the world who find the allure of the YSEB nearly impossible to resist cannot help but hesitate for a moment before they commit to any large investment within the YSEB; they need to reflect on this still mysterious and ominous northern half of the Korean peninsula. Although North Korea is continuously unpredictable in its relations with the world, what is growing less difficult to comprehend is that changing political and economic dynamics surrounding North Korea are creating irresistible tidal currents that are every day sweeping into this last vestige of a once-united hermit kingdom. What South Korea and China are trying to tell the world is: Leave this to the economic and political forces of the YSEB to deal with; change is inevitable and is only a matter of time. From the YSEB perspective, no component of the YSEB is insulated from any destabilization of Koreas northern half. The ramifications for all of Asia from any adverse situations occurring within such a concentrated region, which counts the political, financial, and economic anchors of China and Northeast Asia within its limits, are not difficult to comprehend. Therefore, if one understands that North Korea is the target of a pincer movement of economic forces, driven by the correlated self-interest of both China and South Korea (aided through this same self-interest by Japan), one also understands that political and economic changes in North Korea are inevitable. The United States, once the bulwark of the balance of power in Northeast Asia, becomes an interested but vital bystander in this sea of change, ensuring stability during this period of political and economic realignment. This is the role the United States should play in order to ensure stability within the YSEB while forces other than military drive political and social change in Koreas northern half. Again, from the perspective of the dragon: if the head is sick, the body will suffer. The instinct for selfpreservation will drive the pragmatics of change; and a new era of stabilization, economic integration, and

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eventually even political unification within the Korean component of the YSEB region appears inevitable. Taiwan Serious issues remaining just outside the YSEB continue to present a threat to regional stabilization; of major concern is Taiwan. Although Taiwan lies just outside the YSEB rim, destabilization of Taiwans status quo with China could act as a gate that conceivably could slam shut and bottle up the economic flows of the Yellow Sea. China has already expressed clearly that it is willing to sacrifice economic expansion and, therefore, regional stabilization to maintain its claim over the island, a small but vital doorway to Northeast Asia. Role of the United States in the Yellow Sea Economic Basin The U.S. role in Northeast Asia therefore becomes one not so much of defending democracy within the region but of ensuring gradual and stable change within the region that will lead to more open and more democratic societies. The guiding principle of this presence should be focused on the core belief that economic growth influenced by the forces of globalization will do more to promote freedom and democratic change than any state resulting from military confrontation ever could. The U.S. presence in Korea also creates an interesting perspective on the regional balance of power. Korea now faces the daunting task of maintaining its relevance in a region in which Chinas exponential growth, economic expansion, and sheer size gobble up investment from around the world with the force of a galactic black hole. It is not difficult to discern that, within 20 years, China will become a world leader in nearly all industrial and technological sectors. Chinas perception of policies driven by its self-interest, backed up by what will soon become one of the worlds most powerful military forces with the sophisticated technological platform to project that power beyond Asia, may conceivably come into conflict with Korea and Japan. Chinas policy may be interpreted not so much in terms of its desire to dominate its neighbors but rather to ensure its internal stabilityhistorically, its greatest weakness. Therefore,

China may pursue policies that, while not intentionally detrimental to its immediate neighbors, might have considerable indirect effects. The U.S. presence in Korea then acts as a surrogate that maintains the power balance in the region and also projects Koreas interests beyond what the current economic and political base would normally provide. The U.S. military presence in Korea becomes not so much a peninsula-centric stabilization force but a platform for providing Korea with equality in ensuring its relevance and role in the momentous changes occurring within Northeast Asia. At the same time, Korea can present an independent posture vis-vis the U.S. presence on its soil, maintaining that its support of this presence is tied solely to U.S. effectiveness in ensuring stability on the peninsula and that the presence is not, in fact, a regionally focused vehicle for promoting equal status for Korea among its militarily and economically powerful neighbors. From this point of view, Koreas relationship with the United States then becomes an even more relevant and expanded manifestation of the dynamics of symbiotic alignment. History shows that Queen Min, the last empress of the late Chosun dynasty, once promulgated very similar opinions. Conclusion Through all these forces, the realization that the YSEB region is the platform and determinant for stability within Northeast Asia allows a new perspective on the extraordinary opportunities and potential challenges inherent in harnessing the latent power of this vital arena. The future of one component of the YSEB is indelibly linked to all others of the YSEB, and the dragon, in turn, now exerts an ever-increasing influence on the direction of stability, peace, and prosperity throughout Asia. For Korea, a vital component of the Yellow Sea area, harnessing the momentum of the rising dragon promises an unmatched opportunity to overcome 50 years of traumatic internal schism, with the aim of achieving the long-cherished dream of unification. For China, stability within the YSEB is a cornerstone of achieving its goals to become a major political and economic force within the world forum. For Japan, YSEB stability and growth represent enormous market oppor-

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tunities to feed its own industries. For East Asia as a whole, the rising dragonthe YSEBrepresents both opportunities and challenges as the drivers of economic growth throughout Asia continue to shift from South to North. The dragon is rising, and the world is on notice. Mr. Doran is a partner at Doran Capital Partners Korea. He is also the managing director and chief investment officer at Gale International (Korea) and is leading the project financing team for the development of New Songdo City in Incheon, South Korea.

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