When Chung Un-Chan speaks of a nation once “paralyzed by anxiety and uncertainty,” it’s hard to imagine that the prime minister of South Korea is indeed referring to his own country. Exuding pride and confidence today, Korea — as Chung is also quick to note — is among the world’s largest economies. It’s also at the forefront of today’s global economic recovery, making one of the strongest rebounds registered by any member of the Organisation of Economic Co-operation and Development (OECD). Growth bounced back in the third quarter of last year while this year, GDP is predicted to grow 5.8% followed by 4.7% in 2011, says the OECD. It’s a far cry from the Korea of the 1950s and 1960s, which had one of the lowest per capita GDPs in the world.

But for many Koreans, it’s been a journey “that carries deep emotions,” Prime Minister Chung acknowledged in his keynote address at Wharton’s Global Alumni Forum in late May. The primary focus of the forum — held in the Korean capital Seoul and titled, “A Whole New World: Where Do We Go from Here?” — was to take stock of the global economic recovery. But it also served as a poignant reminder of the host country’s particularly remarkable resiliency: The last time a similar Wharton gathering was held in Seoul was 1999, as the country reeled from the Asian currency meltdown and was negotiating a humiliating bailout plan with the International Monetary Fund. Yet back then as today, Chung recalled, Korea “surprised the world” and recovered far faster than expected.

While the challenges Korea faces today might not be as formidable as they were some 10 years ago, the country can’t stand still. “The Korea of yesterday isn’t the one of today, or tomorrow,” conceded Chung. In the months ahead, can Korea prove that — as in the late 1990s — it can come out of this current crisis stronger than before with an economy that’s more shock-resistant than ever?

Tense Times

It won’t be easy, for both new and old reasons. As the prime minister spoke, relations between South and North Korea were faltering yet again following the sinking in March of the South Korean naval ship Cheonan in the Korean peninsula, which killed 46 South Korean sailors. Though still denied by Pyongyang, an investigation found evidence that a North Korean submarine had fired a torpedo at the Cheonan. Under the stress and strain of the renewed military and political tension, a dark cloud hovers over both countries.

It’s against this geopolitically charged backdrop that the conservative government of South Korea President Lee Myung Bak must keep Korea Inc. focused on sustaining the economic recovery. Severed relations with the North are unlikely to harm South Korea’s recovery directly — annual trade with the North accounts for only $286 million, or about 0.3%, of South Korea’s GDP. And thus far, other economic fallout from the Cheonan incident has been minor: Since the investigation’s findings were made public in May, the benchmark Kospi stock market index fell only slightly and the won began some seesawing against the U.S. dollar. But nerves could fray further if South Korea fails to get the international support it wants to reprimand the North. Indeed, the psychological importance of peaceful relations with the North can’t be underestimated

Lee — a former CEO of Hyundai Engineering & Construction and former mayor of Seoul — started 2010 basking in international praise and admiration for his administration’s swift response to the downturn. In November 2008 — faster than many other governments — Lee announced 14 trillion won ($11 billion) of spending and tax cuts as part of the country’s stimulus plan to address unemployment fears and the staggering drop in export demand. Meanwhile, the Bank of Korea, the country’s central bank, began a series of interest rate cuts, eventually bringing the base rate to a record-low 2%, where it remains today. With only one quarter of negative growth during the downturn (a 5.1% contraction in the last three months of 2008), such measures seem to be achieving what they needed to.

But, as panelists and presenters at the Wharton forum agreed, the current administration wouldn’t have been able to achieve what it did had it not been for the painful reforms undertaken after the crisis in the 1990s. Up to then, Korea’s development model relied precariously on huge amounts of short-term foreign borrowing, shockingly high corporate debt levels to fuel industrial growth, and far too cozy ties between government and local business aimed at keeping foreign investors at bay, according to Alex Park, managing director of Standard Chartered Bank First Bank in Seoul and one of the participants in a forum panel titled, “The Future of Finance.” But then Korea Inc. unraveled. Starting with Daewoo Motor in 2000, dozens of other subsidiaries and divisions of the country’s once powerful chaebol — the industrial conglomerates involved in everything from shipbuilding to television manufacturing — went bust.

Outlook: Sunnier

Contrast that to recent months. Having cleaned up their balance sheets — and their governance — the chaebol took advantage of government incentives and the tumbling won (which had lost 17% of its value against the U.S. dollar over the past year) to grab more overseas sales. Samsung Electronics almost doubled its operating profit in 2009 from 2008 to 10.9 trillion won, while profit for the year at LG Electronics reached a record 2.9 trillion won. At Hyundai Motor, 2009 profit also soared to 2.9 trillion won. Like other parts of Korea Inc., all three are upbeat about their 2010 prospects.

Korea’s achievements haven’t gone unnoticed. In mid-April, ratings agency Moody’s Investors Service upgraded its sovereign rating to A1 from A2, ranking the country with China and Israel in terms of international creditworthiness, notes the latest country analysis published by the Economist Intelligence Unit (EIU). “The rating move returns South Korea to its position before the 1997-98 Asian financial crisis,” says the report. Thanks to economic resilience, the government’s well-timed measures, and the soundness of both the public finances and the private financial sector, “the rating upgrade also functions as an assurance that the persistent geopolitical risks posed by North Korea have not dampened growing economic optimism in South Korea.” 

But while support for the Lee administration at home might be relatively strong, it’s not unquestioning. “Lee campaigned in 2008 saying he was going to run the country like a business,” says Philip Nichols, Wharton professor of legal studies and business ethics and one of the moderators at the Seoul forum. After more than a decade under a center-left government, “some Koreans love [Lee’s pro-business approach to governing the country]; others are put off. I tend to think he’s a capable administrator.” But it appears his foreign policies toward North Korea — ending the previous government’s conciliatory “Sunshine Policy” of economic cooperation — have been even more divisive.

South Koreans used local elections in early June to show the president what they think of his hard-line policies severing ties with the North in the wake of the Cheonan sinking. Lee’s Grand National Party (GNP) clinched only six out of 16 mayoral and gubernatorial races across the country, half the total of four years ago. The opposition Democratic Party said “the Lee government’s arrogance and self-righteousness” are to blame for its party’s dismal election results, widely considered a mid-term referendum for the president.

Labor Pains

It’s the longer-term issues that could prove more vexing for Korea. One such issue having a far-reaching impact on national productivity and employment has to do with the country’s low birthrate and aging population. At 48 million currently, Korea’s population grew 0.5% on average between 2005 and 2009. The OECD predicts that it will fall by 0.02% in 2020. According to Statistics Korea, the national statistics office, Korean households without children and one-person households will exceed households with children in 2030. Among other things, that will severely strain public services, noted Kee Taig Jung, a professor of health services management at Kyung Hee University in Seoul and a participant in the forum’s panel titled, “New Healthcare in an Ageing Society.”

What’s more, a declining workforce has important implications for a country that until now has largely relied on manufacturing as its economic engine. “Considering Korea’s stage of economic development and its changing demographic structure, including the aging of the population, little is to be gained by continuing to follow a growth strategy relying on the expansion of inputs of capital and labor,” said Kim Choong Soo, the Bank of Korea’s new governor, in a speech at the forum.

Technological innovation is one way to produce more with less; shifting the economy’s emphasis from manufacturing to services is another, say experts. That means Korea has a lot of work ahead. Only four of its 30 largest enterprises are part of the service industry and account for 58% of GDP, compared with 12 of the top 30 in the U.S. accounting for 80% of GDP, according to Richard Dobbs and Roland Villinger, two Seoul-based directors at McKinsey. What’s more, the productivity (output per labor hour) of Korea’s private sector services “is only 56% of manufacturing productivity, in stark contrast to other developed nations where the two are about the same,” write Dobbs and Villinger in Korea 2020, a new book by the consulting firm.

To sustain GDP growth, the two McKinsey consultants say overall labor productivity will need to increase 26% more over the next two decades than over the previous two. The first step in addressing the imbalance, they advise, is for both business leaders and the government to increase the proportion of R&D budgets spent on services. The process could also require scrapping fiscal and financial policies that have favored manufacturing, a prospect that might not sit well with Korea’s business community over the short term.

But not everyone agrees with Dobbs and Villinger. “I am not sure whether we can or we should start developing a services sector now,” said Chelsoo Kim, an economics professor at Sookmyung Women’s University in Seoul and a participant in “The Future of Finance” panel. “Korea’s comparative advantage is in the manufacturing sector, not in the service sector. Although diversifying into services may be useful, I think Korea should try to concentrate on what [it] does best right now.” He also pointed out that not only is Korea’s macroeconomic house now in order, but its exporters are more diversified geographically than they have been in the past, “and hence less vulnerable to a particular country’s downturn than before.”

Home and Away

As Kim observed, there is more to the sustainability of Korea’s economic recovery than internal reforms and politics. That much was made clear when the United Nations Development Program (UNDP) office in Seoul recently closed. Opened more than 40 years ago, the office was a reminder of Korea’s impoverished past and its need for international aid to spur development. That changed in November when Korea was recognized as a full-fledged donor nation by the OECD Development Assistance Committee. As Chung noted in his forum keynote, the new status as a donor country is a source of pride for Koreans.

It also brings Korea to a crossroads, said Diana Robertson, Wharton professor of legal studies and business ethics and moderator of the forum panel titled, “New Economic Leadership of Asia.” As the panel’s participants said, Korea’s hope is to take a long-overdue regional and international leadership role. According to them, Korea should become a sort of “honest broker” on the world stage, given its enviable growth trajectory and current size — neither too large economically to pose a threat to China and advanced countries, nor too small to not wield clout or respect among developing countries.

That role is being cemented this year as it chairs the G20, the group of 20 major industrialized and developing nations, whose leaders will be convening in Seoul in November. Korea’s chairmanship comes with mixed blessings, however, said Wharton finance professor Richard Herring in his introductory remarks as moderator of “The Future of Finance” panel. “With Korea as the first non-G7 country to host the G20, it’s a more accurate reflection of today’s economic balance of power. That’s the good news. The bad news is that it will be a lot harder to reach agreements now that the group has expanded from seven to 20. But it’s going to be an historic occasion.”

It goes without saying that Korea will use its agenda-setting power as chair to get G20 countries to coordinate an orderly exit from their recent expansionary monetary and fiscal policies. But trade politics will be another big area on which Korea will focus G20 members’ attention. “It doesn’t surprise me that [Korea] wants to chair the summit. It plays to their strengths and gives them a sense of being able to show that they’ve made it,” said Simon Evenett in an interview at the University of St. Gallen in Switzerland where he is professor of international trade and economic development. “Korea is known as a tough negotiator, and its pro-market openness underlies its reputation.”

Last year, Evenett was part of a team at the Centre for Economic Policy Research, a London-based think tank, which launched the Global Trade Alert (GTA), a regularly updated database of state measures from around the world that can affect foreign commerce. Currently, there are 960 measures in the database, of which Evenett says 240 adversely affect Korea. Those measures are largely in the form of bailouts and state aid, but export taxes and restrictions as well as tariffs are among the others.

According to the GTA, since the first G20 crisis-related summit in 2008, its members — despite their “no-protectionism” pledge — imposed 316 of what it calls “beggar-thy-neighbor” policies. Some countries — notably Korea — have issued very few. In contrast, among the worst offending nations worldwide is China, Korea’s biggest trading partner, accounting for 17% of all imports into Korea and 24% of all its exports.

“What is imperative is to find a new way forward. Without a sense of urgency, the G20 will lose its focus,” said Evenett. Judging from previous summits, however, “don’t be surprised if [the November summit] becomes a talking shop. But that won’t be Korea’s fault.”

Korea also wants to manage expectations. History has taught veterans of Korea Inc. that celebrating its recent achievements too soon would be “dangerous,” said James Joo-Jin Kim, executive chairman of Amkor Technology, a semiconductor outsourcer he founded in 1968, and the forum’s co-chair. “We survived, we persevered and then we prospered,” he said. “There’s no question Korea is great. But everything is relative…. China and Japan are right next to us. We have to respect that.” Korea also needs to “provide substance” in its newfound role in global leadership. As he put it, “This is only the beginning.”