[Outlook]Bearing up under a stronger won

The exchange rate for the U.S. dollar to Korean won has dipped below 900, whereas at the beginning of last year it was over 1,000.
Broadly speaking, there are two possible implications of this.
First, the price competitiveness of Korean exports, which have led Korea’s macroeconomic growth, will plunge and thus the prospect of national economic growth will be hurt.
On the other hand, this exchange rate is not new to us since it was similar to the level before the financial crisis in 1997. Considering that exports have so far been strong in spite of a continuously weakening dollar, we may not have to worry about the strengthening won.
This second perspective is based on an understanding that the current increase in exports is due to our companies being more competitive. However, because it may have been pure luck that exports have risen so far, the second view is less convincing than it sounds.
Primarily, the rapid growth of the huge Chinese market worked as a positive factor for Korean trade. Total exports to China have increased by double digits.
Other indirect factors that also favor Korean exporters are abundant. The benefits are best represented in the unprecedented growth of Korean shipmakers. Surely this has been due to the fundamental strength of those companies, but the most important reason for their success is that the country that established itself as the factory of the world is absorbing a range of crude and semi-manufactured materials.
In accord with a soaring increase in demand for crude oil and raw materials and with a vibrant global trade, the demand for transport and logistics has leaped.
Another point of consideration is that diversification in the export market does not appear to be directly tied to improved competencies. Whereas our exports to the U.S. market are slowing down, trade with the European and Chinese markets is on the rise.
This is a sign of diversification in export destinations. If that means our competitive edge has improved in the global goods markets, the market share of Korean products in competitive markets should also increase.
Yet our performance in the U.S. market, which is the largest and most competitive due to its openness, is unsatisfactory compared to our past achievements.
That we are increasingly exporting to EU countries is a relieving factor, but again the proportion of Korean products in those markets has also been in decline from 2005 to August 2007. If our export goods become more competitive, they should also have larger market shares in the U.S. and EU markets, yet the opposite is true.
Painful choices must follow in order to maintain price competitiveness in spite of the stronger won. Above all, the cost of production should be lowered. Large manufacturers must be able to ask subcontractors to lower the prices at which they deliver their products.
Labor cost should also be cut. The stronger won means spending on manpower decreases when workers are paid using dollars. Thus we should further reduce hiring domestic workers, particularly considering the rigidity of the Korean labor market.
It has already been pointed out that exports do not produce as many jobs as they used to. This causes additional issues in the move to establish a semi-manufactured materials industry in Korea, which experts have repeatedly criticized. When the won is strengthening rapidly, semi-manufactured materials should be procured from overseas instead of domestically in order to reduce costs.
Nor is it feasible to demand governmental intervention in the market. Due to several reasons, including domestic bond markets, the influx of foreign capital will increase next year.
The International Monetary Fund is seriously concerned about possible governmental intervention. Yet when the capital influx gets bigger, the effect of intervention dwindles whereas the pressure to do so intensifies.
A suggestion to modify interest rates in accordance with the exchange rate is difficult to implement under the current floating exchange rate regime. The weakening dollar is a positive factor for stabilizing domestic prices and increasing consumer purchasing power.
We should consequently be patient with the won’s strength so far. We have to enhance productivity by radically expanding investment and advancing technology. In the meantime, we need flexibility to adjust not only human resources management but also costs.
More fundamentally, however, the foundation of the domestic economy should extend further by increasing domestic demand and consumption.
Only if the national economy’s reliance on exports shrinks will the country be able to quit worrying about small or large changes in the exchange rate.

*The writer is the chief macroeconomist at the Korea Economic Research Institute.

by Huh Chan-kook