Why do some countries prosper and continue to grow from strength to strength while the economic development and growth in others stagnate or, worse, falter and decline? We asked this question some weeks back and, last week, we highlighted two nations — South Korea and South Africa — whose starkly differing economic progress in the past 30 years, after achieving democracy around the same time (in 1993 to 1994), makes for fascinating research subjects.
In this article, we will focus on some of the major factors behind the stories of their economic success and failure, collated from a wide range of publications and research materials. It is not our intention to do a direct comparison between the two countries or, for that matter, against our own. After all, no two countries are alike. Countries differ in terms of land mass, geography, topography and climate. Their populations have a different demographic makeup, such as ethnicity and age, cultural background and historical legacies. The success of South Korea is unique and quite likely difficult to replicate. The point is to highlight the differences and the lessons we can learn from them. Our article does not pretend to be comprehensive or definitive but, rather, aims to raise questions and encourage debate to enhance knowledge and wisdom. In doing so, we hope for a better understanding of what it takes to bring economic progress, prosperity and jobs that will improve the well-being of the masses, and not just the small group of elites and privileged.
South Korea — the innovation-driven economic miracle
South Korea’s evolution from being one of the poorest to becoming among the richest countries in the world is a great economic success story. The first phase of its transformation from agricultural to industrial economy took place from the end of the Korean War up to the Asian financial crisis (AFC).
In the 1960s, large state-owned companies were set up to drive economic development, primarily for exports. Investments as a percentage of GDP rose sharply over the next three decades, and manufacturing was the key driver for growth (see Chart 1). As manufacturing as a percentage of GDP grew, the focus gradually shifted from light industries (textiles, footwear and household appliances) to heavy industrial and chemical products manufacturing (such as iron and steel, ships, machinery and chemicals).
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In the 1970s, these state-owned companies were privatised to family-owned business groups called the chaebols. The aim of the privatisation drive was to reduce government debt, attract foreign investments and create greater competition to further stimulate growth. The chaebols, however, maintained close ties to the government and wielded significant influence with their concentrated economic power and wealth. They continued to enjoy cheap government loans and, sometimes, guarantees, as well as incentives and protective regulations.
The AFC in 1997 was a major turning point for the economy. Structural weakness in the financial sector and over-reliance on foreign money and short-term capital to finance the growth of chaebols sent the economy into a tailspin. The country faced a significant shortage of foreign exchange reserves and its currency devalued sharply, resulting in a liquidity crunch and collapse in investor confidence. The government under president Kim Young-sam, turned to the International Monetary Fund for a bailout and committed to structural reforms in the financial and corporate sectors. It drove insolvent businesses into closures and forced financially distressed chaebols to restructure, divest and streamline their operations, reduce debts and even bankruptcy. There was significant short-term pain — the economy fell into deep recession and unemployment surged. But the crisis and the government’s response to it also spurred the economy on to its next critical transition.
Reforms were undertaken to improve transparency, accountability and governance of chaebols. Further liberalisation of imports and the economy attracted increased foreign direct investment (FDI) — but this also forced the chaebols to compete in the global market. Critically, there was a material step-up, by both the government and corporate sector, in spending for education and R&D, which led to unparalleled innovations (see Chart 2). The country’s Global Innovation Index ranking rose to No 6, from No 19, in the world between 2007 and 2022.
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In fact, South Korea’s spending on R&D as a percentage of GDP is among the most intense in the world and well above that of the US, Japan, Germany and China (see Chart 3). The resulting innovations and technological advancements underpinned South Korean companies’ increasing productivity and competitiveness in the global market. The country’s participation in the global value chain rose steadily over the next decade. Innovation also brought about the next important transformation for the economy. While investment and manufacturing as percentages of GDP stayed flattish post-AFC, there was a notable shift up the value chain. Medium and hi-tech manufacturing accounted for an increasing share of the overall manufactur- ing sector (see Chart 4). The composition of its manufacturing — and exports — shifted from heavy industrial-chemical products to the automotive, information and communications technology sectors.
South Korea’s economic complexity ranking jumped to No 5, from No 32, in the world in the last 30 years (see Tables 1 and 2).
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Technological innovations drove productivity gains — for instance, by upgrading technology, improving the production process, increasing automation and the use of robotics. At the same time, the government improved the ease of doing business in the country and invested in digital infrastructure and online platforms. The aim was to simplify and streamline business processes, reduce bureaucratic hurdles/red tapes, minimise paperwork and enhance transparency. South Korea currently ranks No 5 in the world in the World Bank’s Ease of Doing Business Index, up from No 23 in 2006. The index takes into account factors such as ease of starting a business, getting electricity, dealing with construction permits, enforcing contracts and resolving insolvency.
According to the Asian Productivity Organisation, total factor productivity (TFP) — which measures how efficiently and effectively inputs (labour and capital) are transformed into output — contributed 20% to South Korea’s economic growth between 1970 and 2020 (a higher TFP means the economy can generate more output with the same inputs). And higher productivity translates into higher incomes and standards of living (see Chart 5).
The point is, domestic competition and globalisation sharpened the focus and enhanced the competitiveness of its local companies. It is to innovate and out-compete or die. As we have written before, enduring comparative advantage is borne from competition, not protectionism.
While the chaebols retained substantial domestic market influence, the market-based South Korean economy — with equal opportunities and robust private property protection rights — also witnessed the rise of small and medium enterprises (SMEs), including startups such as Coupang and Naver.
South Africa — the scourge of corruption and state capture
During the years of apartheid rule, investments in the country declined steadily, owing to political instability, economic sanctions, capital flight and limited opportunities for the majority of its population (see Chart 1). Manufacturing stagnated and, with premature deindustrialisation, the economy turned to consumption and government spending to drive growth. Consumption, however, was suppressed by low incomes as well as high inequality and unemployment rates. Economic growth — and productivity — declined steadily through the 1960s to 1990s (see Chart 6). The economy was dominated by a few large companies that led to a concentration of wealth and economic power in the hands of the white minority.
The end of apartheid and swearing in of Nelson Mandela as South Africa’s first democratically elected president was considered one of the greatest triumphs for democracy in the world. Expectations were high. But the country’s transition from more than four decades of institutionalised racial segregation and discrimination has turned out to be far more complex and difficult — despite having inherited a fairly well-developed industrial base (manufacturing) and financial sector, as well as rich natural resources. The majority of its population were poor and poorly educated.
Post-democracy, investments, including FDI, as a percentage of GDP picked up slightly but remained comparatively low. Manufacturing as a percentage of GDP continued to decline (see Chart 1). The economy remained heavily reliant on exports of natural resources, which exposed it to commodity cycles.
The new-found political freedom and power of the majority failed to effectively address the economic structure, which continues to be dominated by the conglomerates and elites from the apartheid years. Huge disparities in income-wealth, including land ownership, persisted. Unemployment rose even higher — as modest economic growth failed to create sufficient jobs and there was a mismatch in skill sets. Despite reform efforts to promote greater economic inclusiveness, the majority of black South Africans, including youths, were poorly educated and ill-equipped to secure better-paying jobs. Access to quality education remained limited.
The African National Congress (ANC) struggled to transform itself from a liberation movement to a modern political institution. The unequal distribution of political and economic power led to the worst kind of corruption — not just bureaucrats extorting bribes to “grease the wheels”, but “state capture”.
State capture is the grand form of corruption, when companies, institutions and powerful individuals hold undue influence in shaping the laws, policies and regulations of the state to their own advantage by providing bribes to public officials and illegal contributions to political parties and candidates. Bribes are made to parliamentarians to “buy” their votes on important legislations and, thus, encode advantages for themselves into the basic legal and regulatory structure of the economy. Examples of state capture include influence over the appointments of key government officials and control over state-owned enterprises, in the award of lucrative government contracts, in the imposition of anti-competitive barriers that generate highly concentrated gains to selected powerful firms at a significant social cost as well as in blocking any policy reforms to remove such barriers.
State capture emerged and intensified under the leadership of president Jacob Zuma from 2009 to 2018 and is directly linked to the “lost decade” for South Africa. The capture economy reduced domestic competition and retarded the growth of SMEs, which further enriched the economic elites and disincentivised investments and innovation. The country’s ranking in terms of ease of doing business and innovation has fallen sharply. Investments as a percentage of GDP started declining anew during this period.
Corruption and mismanagement at state utility Eskom — precipitated by the appointments of key management and members of the board of directors under the influence of state capture, irregular contracts, inflated prices and diversion of funds — resulted in age- ing infrastructure. Eskom is racked by debts. Rolling blackouts have worsened exponentially across the country — by some accounts up to 12 hours daily — further hampering economic growth. Nominal GDP growth (in US dollars) faltered, to just 1.6% a year on average, from 2009 to 2022.
Three decades after democratisation, South Africa has the highest inequality rate in the world. One in five South Africans lives in extreme poverty (less than US$2.15 a day) and nearly 62% of its population live below the international poverty line (less than US$6.85 a day). Unemployment stands at nearly 30%, and even higher for youths. As we wrote earlier, high inequality and unemployment rates suppress consumption, which accounts for a disproportionately high 64% of its economy.
The economy has barely transformed, still heavily reliant on mining — the top exports are gold, platinum, diamonds, iron ore and coal — and its economic complexity ranking has fallen from 29 to 58 globally. Manufacturing — the sector that traditionally produces the highest productivity gains — as a percentage of GDP has fallen sharply. There was no move up the manufacturing value chain. In fact, productivity (GDP per capita) has fallen 22% in the past 10 years, owing partly to a high unemployment rate.
So, what are the major differences between the two ‘Souths’?
As we said at the start of this article, our intention is to highlight the major differences between the two countries and, more importantly, what lessons we can learn from their experience. The key differentiators are the extent of free-market competition and corruption and, critically, equal opportunity and access to, and the quality of, education.
The AFC was a major turning point for South Korea. Its economy was able to grow and prosper because, at the height of the crisis, the government chose market-based reforms over protection of local companies. Opening the domestic market to competition forced the chaebols to restructure and expand globally. To compete in both the domestic and global markets, companies spent heavily on R&D, which, in turn, drove innovation and technological advancements — and moved up the value chain. Samsung, Hyundai, LG and Lotte are, today, all reputable global brand names.
The South Koreans have also made significant efforts to combat corruption and improve governance and transparency over the years. It has demonstrated commitment to enforcing anti-corruption laws, including high-profile prosecution and imprisonment of former presidents and prominent business figures. Having said that, the recent presidential pardons for former president Park Geun-hye and Samsung heir Lee Jae-yong show that conflicts remain. Nevertheless, the country’s score on the Corruption Perception Index has improved from 56 to 63 since 2012, and it now ranks 31 among 180 countries.
In contrast, there was limited economic transformation in South Africa, no thanks to growth in patronage networks and systemic corruption. The country is ranked 72 in the global corruption index by Transparency International. Economic wealth and power remain in the hands of a small group of elites while the majority of the population are impoverished as economic progress stagnated. State capture has reduced South Africa’s international competitiveness. Corruption and mismanagement eroded public trust, including in the ANC. Intergenerational mobility is low — inequalities are being passed down from generation to generation — fuelling crime and societal unrest.
Perhaps the most critical difference is in the quality of education. A country cannot attract high-value investments if it lacks the required talent pool to support those businesses. And you need an educated workforce and necessary skill set to move up the value chain. Without an educated and talented workforce, R&D spending will go nowhere.
Based on the latest available statistics, about 40% of South Koreans possess a diploma or higher education compared with less than 14% in South Africa. Equal access to quality education and skills development remains a key obstacle in South Africa. And, although the country spends a relatively high percentage of its GDP on education, the quality of teaching (lack of skilled teachers) is an obstacle — its students scored lowly in in- ternational assessment of knowledge on science and mathematics (the TIMSS series established by the International Association for the Evaluation of Educational Achievement) (see Table 1). It is not an over-statement to say that education is a powerful predictor of the wealth that countries will produce in the long run. Human capital is the most valuable resource of a nation.
We would be amiss not to point out one more factor that often goes unmentioned in research and analyses — race and ethnicity. South Korea is a homogeneous race and culture whereas South Africa has to contend with race as a divisive element. There is no question that race is a polarising factor. How a country’s political and economic institutions are structured to deal with the differences will have a great impact on its economic development. Next week we will conclude this 3-part series by bringing together all that we can learn from the experiences of these two countries and relate them to Malaysia.
The Malaysian Portfolio gained 0.8% last week, led by KUB Malaysia (+9.8%) and Hartalega Holdings (+2.5%). Star Media traded unchanged while Insas fell 1.8%. Total portfolio returns now stand at 160.3% since inception. This portfolio is outperforming the benchmark FBM KLCI, which is down 20.8%, by a long, long way.
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