Saturday, October 18, 2008

South's Korea's Export Juggernaut

JUST as South Korea, in historical terms, sees itself as a little thing among overbearing powers, so many of its businessmen and policymakers now feel that the country’s export machine, the thumping heart of the economy, is being squeezed by two giants. On one side is Japan, whose high technology and sophisticated production give it an edge in exports. On the other is China, whose low wages allow it to compete ruthlessly on cost, even as it learns to make ever more complex products. What, South Koreans wonder, is their economy’s place in Asia’s future?

They may be overreacting. Certainly, China’s rise up the production chain has been swift and, in some cases, ferocious; and the South Korean won has been the strongest of the region’s currencies since Asian growth took off earlier this decade, even if it has softened somewhat this year. Yet South Korea has responded admirably to increased competition and a stronger currency, notching up double-digit export growth for the past five years. It is now the world’s tenth-biggest exporter, and apart from a cyclical slump in Asian export growth that appears to be caused by America’s and Europe’s sharply slowing economies, there is plenty of reason to think that its success can continue for a while.

To date, China has proved a boon for South Korea’s exports. Having overtaken America in 2003 to become South Korea’s largest trade partner, it runs a bilateral trade deficit thanks to large imports of capital equipment and parts from South Korea. This growing bilateral trade reflects the knitting-together of production networks all over Asia, centred on China. China’s share of South Korea’s total exports of unfinished goods—that is, parts—rose from just 1% in 1992 to 27% in 2004, according to the IMF. Now China’s bilateral deficit is narrowing as South Korea imports more intermediate goods from there. Yet much of this is the result of South Korean investment in China.

South Korean manufacturers are still improving their own competitiveness. Partly thanks to modest wage growth, labour productivity in manufacturing has grown by an average of 10% a year since 2002. Indeed, the stronger won appears merely to be the flip side of that productivity growth. Currency strength, certainly, is squeezing profits in some areas, notably for small- and medium-sized businesses that are less efficient than larger firms, as well as for the big carmakers.

South Korean exports have not only grown but become more sophisticated as production has shifted out of low-value-added goods such as textiles that rely mainly on cheap labour. Korea’s spending on research and development is equivalent to nearly 3% of GDP a year, one of the highest rates among developed economies. According to the IMF, high-value-added products—things like cars, consumer electronics and top-of-the-range ships—now make up half of Korea’s exports, up from a quarter in 1990.

South Korea today is more of a whale than a shrimp in several global industries. In memory chips it is home to the world’s biggest maker of flash memory (Samsung Electronics) and the two biggest makers of DRAM chips (Samsung and Hynix). It has the third-largest steelmaker (POSCO), the fifth-largest carmaker (Hyundai Motor), and the world’s three biggest shipbuilders (Hyundai Heavy Industries, Samsung Heavy Industries and Daewoo Shipbuilding & Marine Engineering, or DSME). It is a leading producer of mobile handsets and of LCD screens for televisions, computers and much more.

Heavy industry, as Shaun Cochran of CLSA, a brokerage, puts it, is the country’s “sweet spot”. Take shipbuilding. As Hyundai’s founder, Chong Ju-yung, was boasting posthumously in those television advertisements this summer, there was no shipbuilding industry in South Korea until the 1960s. When the country’s dictator, Park Chung-hee, summoned Chong and told him to produce oil tankers, for which there was a sudden demand, Chong went straight to Greece and scooped up two contracts to build 260,000-tonne tankers, promising his customers delivery within two years, sooner than anyone else. He had neglected to mention that at that moment he lacked even a shipyard. He then waved the order in front of Barclays Bank, which lent him enough money to build a modern yard. No one in South Korea knew how to do that, so Chong dispatched 60 engineers to Scotland to learn. The ships were delivered before the deadline. This famous story, concedes Bruce Cumings of the University of Chicago in a refreshingly revisionist modern history, “Korea’s Place in the Sun”, may be apocryphal in its details, yet it has a strong whiff of truth about it.

Korea’s three big shipbuilders are thriving. Competing fiercely against each other, though by unwritten agreement not for staff, their order books are nearly full up to 2013. South Korea has two-fifths of the world market in new ships (which account for 8% of its exports), whereas China and Japan have to make do with a quarter-share each.

Seen from a helicopter, the vast DSME yard at Okpo Kojé island, near the south-eastern industrial port of Busan, looks impressive: great walls of steel rise up from the dry docks as enormous gantries offer up bows and other hull sections to assemble the world’s biggest container ships, liquefied natural gas (LNG) carriers and giant floating depots for storing and processing offshore oil and gas. On the ground, all notions of human scale are lost.

DSME’s chief executive, Nam Sang-tae, says that China is not a chief competitor, despite the state aid from which its shipbuilding industry has benefited. It cannot match South Korea for prompt delivery, and although Chinese shipyards offer low costs, they turn out relatively low-tech vessels, such as bulk carriers and run-of-the-mill oil tankers. South Korean yards are more interested in building, say, high-tech LNG carriers, which keep their cargo at -163ºC.

A new type which Daewoo Shipbuilding was the first to build regasifies the methane before it is piped ashore. The design and manufacture of deep-sea rigs, much in demand now that many oil and gasfields on the world’s continental shelves have been exploited, is even more challenging than building advanced ships, and offers higher profit margins; indeed DSME wants to operate as well as build specialised offshore oil rigs because oil companies pay such lucrative fees.

All the South Korean shipbuilders throw a lot of money at research and development. Each has a large design institute, and they generously support university engineering faculties.

Mr Nam is also sanguine about the effect of shipping’s notorious boom-and-bust cycles on his business. Patterns of global logistics are changing, he says, spurred by a growth in world trade and a China-led hunger for resources, so more ships are needed overall, not just new kinds. Climate change, Mr Nam says, offers further opportunities. The potential viability of Arctic sea routes in future is prompting a demand for vessels strengthened to withstand ice. Another growth area is “winterising” oil rigs to cope with drilling in cold climates. Pressure for cleaner transport also helps (bunker fuel used by most of the world’s shipping is filthy).

Okpo is a company town where DSME has its own hospital, cinemas and international school for the families of overseas clients who come to keep an eye on their ships under construction. There are dormitories for single young men and women respectively, one on each side of the bay. Internet forums host thriving dating and matchmaking services, and newly married couples get to move out of the dormitories into their own flats. The town has an income per person of over $30,000, the second-highest in the country.

Iron constitution
Daewoo Shipbuilding was nationalised when the Daewoo chaebol of which it formed a part continued to pile up debts even when the financial crisis was over, entering new businesses with what turned out to be criminal insouciance. Kim Woo-choong, the chaebol’s founder, eventually admitted to accounting fraud and embezzlement worth over $30 billion, and in 2006 was sentenced to ten years in jail before being pardoned. Yet the company’s shipbuilding arm has thrived.

The government has floated a minority of DSME’s shares on the stockmarket. Later this year it is due to sell the controlling stake to one of four prospective buyers. Among the bidders is POSCO, the shipbuilder’s main steel supplier, which itself was started from scratch by the state in the late 1960s, using $120m of war reparations paid after Japan and South Korea normalised their relations. Foreign investors and development experts in Washington, DC, had given warning that a dirt-poor country like South Korea should not aim for self-sufficiency in steel. Yet the company, which was privatised after the 1997 financial crisis, has become a symbol of national pride. POSCO fed the country’s industrial beast and is now, by several measures, the world’s most efficient steel producer.

South Korea’s industrial structure is unusual, says POSCO’s boss, Lee Ku-taek. Its steel consumption per person is the fourth-highest in the world, yet most of the steel eventually goes overseas: nearly 100% in the case of POSCO’s shipbuilding clients, and 60% in the case of Korean carmakers. The steelmaker also serves South Korean construction companies abroad, for example in Dubai. Its customers’ eagerness to conquer fiercely competitive markets overseas may have kept POSCO lean. “Steel’s competitiveness here has made South Korea what it is,” says Mr Lee, “and I’m hugely proud of that.”

Now that he is hoping to buy DSME he sees the chance to double the shipbuilder’s value, which the stockmarket currently puts at $6 billion, by concentrating on complex products such as oil rigs. In shipbuilding, Mr Lee points out, the less you need to weld, the more you save. POSCO, he says, can tailor plates to specific ships, making the product much cheaper.

After two decades of building up its domestic market, says Mr Lee, POSCO will spend the next two decades establishing a powerful presence overseas, through greenfield sites and acquisitions, including in mines that can secure the company’s supply of ore. It will be following the example of South Korea’s consumer-electronics companies, which sometimes used almost military methods for their push overseas. At LG Electronics (LGE) they tell a story of a country manager who was dropped into Algeria during the civil war when other multinationals kept away, put off by the risk. When he emerged several years later, he had built up a multimillion dollar franchise.

The country’s biggest successes in consumer electronics are LGE and Samsung Electronics. Only a decade ago consumers abroad hardly knew them, and if they did it was as makers of cheap knock-offs of classier brands, notably Sony. Today they have annual sales of $43 billion and $92 billion respectively, along with a reputation for making hip and sophisticated mobile handsets, MP3 players, televisions, digital cameras and more. LGE, for instance, is the world’s largest maker of plasma televisions; Samsung has recently overtaken Motorola to become the second-biggest maker of mobile phones. Samsung’s stockmarket capitalisation, at over $80 billion, has raced past Sony’s and is second only to Apple among consumer-electronics companies. Samsung Electronics now makes the televisions on which Sony sticks its name badge.

All we need is love
Dermot Boden, LGE’s new chief marketing officer, explains that much still needs to be done to realise the company’s global ambitions, but his appointment, as a non-Korean, indicates the direction in which the best South Korean companies are going. South Korean companies, like Japanese ones, tend to recruit managers internally, rewarding length of service and often putting generalists into positions calling for special expertise. Exceptionally, LGE this year brought five overseas specialists to form part of the 20-strong top team of executives, among them Mr Boden, an Irishman who had earned a reputation for building consumer-goods brands.

Branding, says Mr Boden, is what LGE needs now. The company has superb products and offers excellent service. (It needs to in South Korea, where impatient customers put down the phone if it is not answered within ten seconds.) Yet emotional attachment to LGE’s products, Mr Boden points out, remains low. Products come and go: a new mobile-phone model, for instance, is typically on sale for only about six months. It is a brand that encourages the customer to keep coming back—and if he likes LG mobile phones, he might consider buying, say, an LG television. Samsung has already gone down this road, raising its profile by sponsoring the Olympics and Chelsea football team.

No comments: