Spend just a few minutes visiting the Nanjing Economic & Technological Development Zone, and you'll quickly understand the scale of South Korea's ambition in China. Ten months ago, LG Group -- the No. 2 conglomerate in South Korea -- opened a plant that can churn out 3.6 million liquid-crystal display screens annually. That's one screen every 20 seconds swooping off each of three production lines at the spotless, orderly factory. Cross the street -- recently renamed LG Road by grateful Chinese authorities -- and you'll come to another LG factory churning out plasma screens. In all, LG has invested $2.5 billion in China. It pays its 2,200 highly skilled workers in Nanjing an average of $317 a month -- more than twice the average Chinese factory wage but about one-seventh the pay for similar jobs in Korea. "If you don't have a credible presence in China, you won't be able to compete," says Kim In Ki, the head of LG Electronics Nanjing.
Korea's turbulent politics are at the top of the news in Asia these days. How could it not be, with President Roh Moo Hyun impeached and legislators hurling furniture at each other on the floor of the National Assembly? And political paralysis is a big issue for Korea, which still needs to reform its corporations and clean up a battered consumer sector.
But if every Korean could spend a few minutes on LG Road in Nanjing, they would see instantly what the No. 1 issue for Korea is: China. How to profit from it. How to grow with it. And above all, how to survive with it. In the shadow of China, the political drama in Korea looks like dangerous self-indulgence. Korea's political class should be preparing South Korea for what's shaping up to be both the biggest opportunity and the biggest threat to the country's economy since the Korean War. Even the Asian financial crisis, severe as it was, may prove to have less of an impact on Korea's future than China will have. "Certainly, China is by far the greatest challenge facing us now," says Kim Joo Young, deputy director of Korea's Overseas Economic Research Institute, part of the Export-Import Bank of Korea. "Politicians who keep adding uncertainty are pathetic."
Korea's economic fortunes are already more closely connected with China than any other country, with the possible exception of Taiwan. Last year, South Korean businesses invested more in China -- $4.4 billion -- than U.S. companies, who poured in $4.2 billion. China last year overtook the U.S. as the top destination for Korean exports. This year, the gap will widen, as exports to China jump 35%, to $47.5 billion, compared with a 7% rise, to $36.7 billion, in exports to the U.S. Korea, in fact, would have sunk into recession last year if it weren't for its Chinese trade, which accelerated 50% in 2003.
The transformation has been astonishingly fast. Just 10 years ago, Korea's focus was still on the U.S. market, and its foreign relations were centered on Washington. Now, not only are companies like Samsung Electronics Co. and Hyundai Motor Co. looking to China for their next sales surge, but the Koreans are beginning to look on the Chinese as the regional leaders in diplomacy and statecraft, especially as Beijing tries to untangle the knotty North Korea question. "We are experiencing the first phase of a major shift, where China is increasingly asserting itself in economic, diplomatic, and cultural arenas," says Um Jong Sik, director-general of a presidential committee that aims to boost business ties with Korea's neighbors.
The business ties are rapidly becoming indissoluble. Some 25,000 Korean companies -- many small or midsize -- manufacture in China, and a dozen or so new ones make deals everyday. Korea's leading zipper maker, YBS, last year made $20 million worth of zippers in China. JS International Co. closed its factory in Korea last year and now makes some $8 million worth of shirts every year in China for Japanese brands. "Dyeing and sewing are simply too expensive in Korea," says JS President Park Chang Ik.
Both YBS and JS International's plants are in the northern coastal city of Qingdao, the epicenter of Korea's invasion of China. Known as the home of Tsingtao beer and once a treaty port controlled by Germany, the city is home to 4,000 Korean companies and 70,000 Korean nationals. Three flights daily link the city to Seoul, a hop across the Yellow Sea, and the streets are lined with barbeque restaurants with names such as Korea House. "This is one city in China where you don't need to speak Chinese to do business," says Jang Oh Soo, secretary-general at Qingdao's Korean businessmen's association.
So far, there's little doubt that China has been a blessing for Korea. Some, though, fear the joyride may be short-lived. If Seoul gets too dependent on China, the thinking goes, it could end up as a satellite, with little competitive advantage intact to keep South Korea growing. An early warning sign: Korea's National Science & Technology Council in December reported that Korea is only 1.7 years ahead of China in the sophistication of its technology, and that the gap could shrink to zero within five years. In the crucial cell-phone market, Korean companies today only have a two-year lead over their Chinese rivals in terms of new products and technologies. By 2007, Chinese companies will have caught up, Korea's Commerce Ministry says.
Unless something is done to increase Korea's competitiveness, its current $13 billion trade surplus with China will become a deficit by 2011, cautions the Korea International Trade Assn. "China has been a goose laying golden eggs," says Jeon Byeong Seo, head of research at Daewoo Securities Co. in Seoul. So golden, in fact, that last year he required all his analysts to include some discussion of the "China effect" in every report. Jeon warns, however, that "Korea's prosperity will depend largely on how long companies can keep this goose alive."
So far, the benefits have largely flowed to Korean corporations, not their workers. And Korea's labor laws and union contracts may not be flexible enough to adapt to the changes. Since 1992, 770,000 manufacturing positions have disappeared from Korea. In the same period, Korean companies have created well over 1 million jobs in China. "A reckless corporate exodus has accelerated since last year," says Lee Jung Sik, a senior director at the Federation of Korean Trade Unions, whose membership has fallen by 110,000, to 890,000, in the past six years.
The lure of China, however, is simply all-powerful. For their money, Korean companies are getting both a manufacturing platform and access to a thriving market. And it's paying off. LG Electronics Inc. aims to become the world's third-largest electronics company by 2008, and China is key to that goal. LG already employs 31,500 people on the mainland and last year saw its sales of TVs, LCD monitors, cell phones, and white goods there jump 56%, to $7 billion -- some 40% of its global revenues. Samsung's sales in China are expected to grow 19%, to $8 billion. Hyundai Motor aims to sell 900,000 cars in China in 2008, up from an expected 230,000 this year.
Koreans think proximity and cultural heritage give them an edge over their rivals in dealing with the Chinese. In fact, Buddhist and Confucian tradition, introduced to Korea by China, lingers on in the peninsula. "We are more Chinese than the Chinese," quips Thomas Han, general manager at Hangzhou LG Cosmetics Co. "We think in a similar way, and that makes it easier for us to do business here." In both countries, deals are often cut through political connections -- guanxi in Chinese, yonjul in Korean -- and wining and dining potential associates is important. The social side of business in China is not as easy for Western execs, while the Japanese sometimes face hostility over World War II memories.
The Chinese are delighted, of course, at the growing closeness. "In the beginning, Korean companies only invested in labor-intensive industries. Now they are moving to technology-intensive and knowledge-intensive investments," says Piao Changgeng, a professor at the Korea Research Center at Shanghai's Fudan University. "This is good for China and Chinese companies."
The Koreans are also using sophisticated methods to market their products in China. Korean instant noodle maker Nogshim Co., which controls 74% of the Korean market, sponsors a televised go tournament among Chinese, Korean, and Japanese players to improve its brand visibility. It can sell its spicy Shinramyon noodles at three times the price of local products. Nogshim instant noodle sales jumped 38% last year. "Our strategy is to focus on affluent consumers in a handful of big cities, and it's paying off," says Oh Chan Geun, a Nongshim general manager.
Korea's High Anxiety
Customer research is a crucial part of the marketing blitz. Samsung, for example, set up a mobile-phone research and development center in Beijing in 1999 to cater to the fashion tastes of young Chinese. The result: a ruby-red SGH-T508 cell phone resembling a cosmetic compact and doubling as a mirror. It was an instant hit despite its $440 price tag -- more than a third of China's $1,090 gross domestic product per capita.
But while sales and revenue figures for Korean companies set records, there is increasing anxiety among workers at home. For decades, the Korean economy depended on low-cost manufacturing. But the manufacturing arms of the country's textile and shoe makers have largely been relocated to China. Petrochemical, steel, lower-end shipbuilding, white goods, and even electronics -- except for a handful of leading-edge products -- will likely face a similar fate within five years. These industries employ about half of South Korea's workforce, so it is vital for Korea to create more jobs in services and high-end manufacturing, says Woo Cheon Sik, senior economist at think tank Korea Development Institute. "Demand from China will benefit only a small number of leading companies," Woo says. "For the rest, China is more of a threat." That threat is starkly revealed in rising corporate defaults in Korea, which hit an all-time monthly high of 133,195 in January, up 14% from 116,707 a year earlier, according to the Korea Federation of Banks.
Auto parts are another example of the phenomenon. Korean companies last year sold $944 million worth of mufflers, door handles, windshield wipers, clutches, and headlights, more than five times the $169 million recorded in 2002. But Chinese companies are coming on strong. They are already competitive with the Koreans in making bearings, seats and seat belts, air-conditioners, and bumpers.
And the problem goes beyond autos. Parts and intermediary goods account for nearly 70% of Korea's exports to China. But the local content in China's manufactured goods increased to 49.9% in 2001 from 34.8% in 1999, according to the Export-Import Bank of Korea. One victim: Kohap Ltd., a Seoul-based textile firm that once employed 2,000 workers in Korea and had revenues of more than $1 billion. Rapid development of synthetic fibers in China helped push Kohap into bankruptcy in 1998. Creditors are in the process of liquidating Kohap's Korean operations, but its factory in Qingdao is still profitable.
Of course, biting the bullet and moving operations to China is no guarantee of success. Many smaller Korean companies have rushed into the country without adequate preparation or a real understanding of what it takes to survive there. About half of Korean companies employing fewer than 300 people close down within four years of starting operations in China, according to trade officials. To help them survive, the state-run Korea Trade-Investment Promotion Agency and the Korean Chamber of Commerce run a three-month course to educate businessmen planning to set up operations in China so they can make better business decisions.
If Korea had a flexible economy like the U.S. that generated jobs as fast as it lost them, China would not pose as much of a threat. But Korea built its postwar model on one big idea -- to use local cheap labor to undersell the Japanese in the world markets for manufactured goods. Since the Asian financial crisis, that model has changed somewhat, with foreign companies taking over some Korean factories and banks and companies like Samsung competing more on innovation and quality than price.
But Korea still has a long way to go before it's a flexible, job-generating, fully modern economy. Laborious work rules and highly militant unions still discourage hiring. Korea is trying to get around this by forming three special economic zones where the usual work rules will be suspended. But why not just change the rules in the whole country? At this point, that's a choice the political leadership isn't willing to contemplate. "Special economic zones are terms heard only in communist countries," laments Bahk Byong Won, Deputy Finance & Economy Minister. "We are taking a detour by allowing these exceptions."
Developing Korea's service economy would help employ workers displaced by China. But Korean laws still favor manufacturers, which are granted breaks on electricity rates and taxes that service companies can't get. "We don't have the right climate to encourage entrepreneurs in the service sector," admits Finance & Economy Minister Lee Hun Jai. More than 4 million new service jobs have been created in South Korea since 1992, but many of them are for restaurants and hotels. Korea has yet to foster higher-value service industries such as insurance, education, and legal services. And there has still been a net loss of jobs -- a total of 30,000 disappeared last year.
The situation has all the ingredients for a real crisis, with China gradually eating away at Korean jobs and Korea unable to replace them. This is the predicament that Korea's politicians should be trying to resolve. Says Donald J. Johnston, Secretary-General of the Organization for Economic Cooperation & Development: "The two major issues in Korea today are deindustrialization...and competition from China."
Korea's politicians, however, are focusing on politics instead of policy. Maybe they should remember their Korean history. For centuries, Chinese emperors had to give their approval before a new ruler was named in Korea. That's not likely to happen again. But in the future, who will rule Korea's economy? By Moon Ihlwan in Nanjing, with Dexter Roberts in Qingdao