McKinsey Official Cites Hurdles to 'Top-10' Economic Status

The following excerpts are from a speech Thursday in Seoul by Dominic Barton, director of McKinsey & Company. He was speaking to a meeting organized by the Institute for Global Economics. -Ed.

Korea has made a good start in restructuring its economy since 1997, but has a long way to go to complete the job.

Restructuring is not a six-month, 18-month or even three-year exercise. This is a journey of five to over 15 years. According to studies McKinsey has done on about 35 financial or economic crises, no one ever got out of the problems in three years. What we need to understand is that this is going to take a long time to get through. Korea is now in the early phases of what we believe is its restructuring.

Since the 1997 financial crisis, the Korean market has changed dramatically in terms of financial reform and improvement of the business and labor environment. The biggest success has really been in the external environment. Korea's short-term debt fell to $43 billion in May from $64 billion at the end of 1997, and the ratio of foreign reserves to short-term debt rose to 2.2 in May from a dangerous 0.1 at end-1997. The problem is that unless the real economy restructures, that success will not be sustainable over time. Fortunately or unfortunately, Korea is not like Japan. Japan has been able to withstand its situation for over 10 years because of the wealth of the country. Korea does not have that. Without restructuring, Japan will face similar challenges over the next five years.

If we take a closer look at what has happened, Korea was very fortunate because the economic and social environment had been favorable for reform up to now. Explosive U.S. growth fueled Korean exports and labor was able to share in the growth. There was a low risk of inflation and oil prices were at a low level.

The situation is a lot different today. Global economic growth is slowing down, with the U.S. GDP growth shifting from around 5 percent down to 0.9 percent. The engine that helped power others in crisis in 1997 is not there right now.

Korea's corporate sector remains weak. A significant chunk of all industries are experiencing value destruction, and major industries such as automobile, shipbuilding and chemicals are not exceptions. There still is a large portion of Korean companies that can barely pay the interest on their debts. In chaebol restructuring, there have been some improvements, but not many.

Korea in 2010

We believe that the Korean economy on a purchasing power parity basis could and should aspire to becoming a top-10 OECD country by 2010. That implies a growth rate of 6 percent on average, while the OECD is forecasting around 1 percent growth for the top-10 group of countries. Korea could be the world's No. 7 country in terms of per capital income by 2010, and that is the goal that we think the country can achieve

Basically, one of the fundamental problems we've seen in Korea is that labor productivity is half that of the United States today. Only in one industry, steel, is Korea a world leader in productivity. In every other manufacturing industry, Korea is far behind.

Korea will be able to improve its labor productivity significantly. It would not get to the U.S. level by 2010, but could get close to it. That will require some significant shift in terms of what the economy focuses on, a shift away from heavy manufacturing to more of a service-oriented economy which has much higher expected growth rates.

Second, a much more flexible labor market has to be formed because over time, Korea will begin to shift the economy to that of a lot of job creation and job loss, and a lot more productivity improvement in the corporations themselves. So this again is how much labor do we need, or are we using enough capital to help labor in terms of what they are doing?

We estimate that by shifting more towards a service-oriented economy, roughly 3 million new jobs will be created. But in the process, 5.6 million workers will lose jobs or change jobs in 10 years. So labor market flexibility is absolutely critical. Without it, the Korean economy will not get to the goal of being a top-10 economy. In the process, we will see some sectors such as agriculture disappearing or significantly shrinking over time.

Another area that is important in restructuring is that Korea has a large overcapacity. Profit generation is the only way for companies to survive. In some industries, there are too many competitors, and profit generation is impossible without resolving the oversupply issue.

Key imperatives for today

Key mechanisms to further drive changes are corporate governance, capital market development, labor market reform, aggressive leadership and political reform. If we were to pick one, it would be corporate governance because it can drive the others, except only for political reform.

According to McKinsey's survey last year of institutional investors around the world, many were willing to pay a premium for good corporate governance. In Korea, investors are willing to pay about a 23 percent premium for good corporate governance.

Only 42 out of 73 Korean companies have filled more than 80 percent of their board seats with independent directors. Eight out of 10 outside directors were handpicked by company owners or executives, according to McKinsey's study of 170 Korean firms.

Also in the long term, education should be reformed. Korea spends the highest amount of money per capita of any country in the world on education, but the output of the higher-education institutes in terms of research is significantly lower than in other countries.

As for research and development policy, more focus should be put on specific areas of technology and more private sector and foreign involvement is necessary.

by Kim Hyun-chul