From Bad Dude to Mr Nice Guy?

Please note the disclaimer at the end of this Blog.

If a week is a long time in politics, then a year must seem like an eternity, especially for those following the ups and downs of the political drama on the Korean Peninsula. As we enter the second half of 2018, let us wind the clock back 12 months to see how far we have travelled. In mid-2017 events in North Korea (DPRK) threatened to disrupt regional harmony as the escalating war of words, name calling and military muscle flexing threatened to take the region to the brink of war and led to the imposition of sanctions by China on South Korea.

Then, with the dawning of the New Year 2018, came a notable reduction in tension culminating in the historic meeting in April between Kim Jong-un and Moon Jae-in in the Truce Village of Panmunjom. Surely nothing could Trump this historic moment, unless Donald Trump himself were to join the party. Sure enough, the most unpredictable of US Presidents shocked the world by agreeing to a Singaporean summit with ‘the bad dude’. Of course, it is too early to tell if the summit has left a lasting legacy, but what is certain is that two reputedly vain leaders have invested political capital in kick-starting a dialogue which, should it fail, would be likely to reflect negatively on them.

So, what was agreed and what will the impact be? The joint statement, described by the President as ‘very important and comprehensive’ appears deliberately vague with a commitment to establish new relations aimed at boosting prosperity and delivering a lasting and stable peace, including a complete denuclearisation of the Korean peninsula. These are fine objectives which, if reached, could be extremely positive for North and South Korea as well as many of their neighbours, including Japan which clearly feels threatened by the DPRK’s missile program.

Direct savings could come in the form of reduced defence spending. The US State Department estimates that the DPRK spends an average of c. 23% of GDP on military activity per annum. That is twice the next highest country on the list (Oman) and nearly ten times the global average. South Korea is relatively thrifty at 2.6% of its much larger GDP but the Seoul government still occupies a top 10 spot in terms of US$ spent on their military. Other regional powers on that list include China, Japan, Singapore and India. Clearly, a de-escalation in regional tension will not free-up all these resources but it should help the two Koreas to free-up billions of dollars for more productive use elsewhere.

There are other benefits to consider besides these direct financial ones. The DPRK has a large and well-schooled population, with the highest literacy rate in the world but with an untested degree of enterprise. Any normalisation of trade and cross-border cooperation between the two Koreas would allow companies in the South to benefit from a previously untapped pool of human capital in the North. The DRPK has multiple competitive advantages over other outsource nations including geographical proximity, a common language and a lower-cost workforce. South Korea has been taking advantage of such outsourcing opportunities for years, as its own cost base has continued to rise and has started to tap markets such as Vietnam where companies like Samsung have extensive production facilities. Vietnam, and other outsource locations, may be a little less enthusiastic about the thawing of North-South relations.

The South stands to benefit in another way if a lasting peace leads to erosion of the long-held ‘Korea Discount’. This is a phenomenon which has blighted South Korean listed companies for decades as foreign investors have attached a ‘risk premium’ to these businesses because of the perceived threat to national security. Admittedly, Korean valuations have also been held back as companies have been slow to adopt good standards of corporate governance but recent developments signal positive progress on this front too. Together, a lasting peace and improved corporate governance bodes well for the relative fortunes of South Korean business.

There are, however, many hurdles to jump before any peace dividend is earned by the people on either side of the 38th parallel. This has been an insurmountable problem for nearly seven decades, where a positive outcome still relies on two of the world’s most unpredictable leaders reaching an agreement. China also has a key role to play in the direction of any outcome on the peninsula, with Xi Jinping currently engaged in a trade spat with President Trump. Indeed, perhaps the Korean question is a positive for continued globalisation rather than protectionism? If he can pull this off, Donald Trump would achieve something that 11 of his predecessors had failed to achieve and with that, become a leading contender for the Nobel Peace Prize - an unlikely outcome this time last year and a potential personal legacy which may just influence his dealings with China in those difficult trade negotiations.

James Hart, Investment Director, Witan Investment Services.


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