By William F. Saunders, II
Wednesday, February 20, 2008 10:25 PM
(Updated Wednesday, March 19, 2008 8:04 AM)

A Perspective on the Globalization of the World’s Securities Markets

By William F. Saunders, II

Managing Partner, Global Net Trading

It has been predicted for the last two decades that the world’s major securities markets would eventually merge into one giant electronically traded market. While that is yet to be realized, we are getting closer every day. World class securities firms are merging with and acquiring other world class firms. Exchanges are following suit and regulators from the major markets are working at an incredible pace to determine how to govern a market of this type and magnitude in a way that protects their respective populations without becoming a hindrance in the process.

What are the benefits to having major global markets? For one, quicker and greater access to the liquidity pools that exist around the world, as electronic trading replaces traders and floor brokers who function with large lines of credit to accumulate inventory and trade. Decimalization has reduced the spreads that rewarded trading professionals for maintaining trading inventory. This development has led to the evolution of trading tools that recognize liquidity in the marketplace, while others are designed to camouflage where those pools reside and who the players are. Although this cat and mouse game has resulted in fascinating new approaches to analyzing markets on a real time basis, the underlying concern about liquidity still exists. The most widely accepted solution to liquidity is access to large pools of funds that provide it; therefore, the more global the market, the larger the players who trade in that market and the deeper the pockets that are needed to prevail. 

ADR’s [1] vs. Ordinaries

A second benefit to global markets is the ability for securities to be traded over a broader base of investors, across borders that have heretofore restricted investors from certain markets. ADR’s, or American Depository Receipts, offer Americans the opportunity to invest in some 1,400 foreign companies whose ADR’s are traded on U.S. exchanges and the OTC market. ADR’s are often issued by foreign companies to raise U.S. investment in their company. ADR’s are not always a direct one-for-one investment in the shares of a foreign company. They can be a fraction of a foreign share, or one ADR can represent several shares of a foreign company. ADR’s trade in U.S. dollars, pay dividends in U.S. dollars and issue communications in English. They are traded like shares of U.S. equities and the market float is professionally managed to be at the same percentage level as the underlying ordinary is in its home exchange to maintain market equilibrium. Variations in price equilibrium, or the spreads, are quickly arbitraged by traders who monitor prices for inequalities between ADR’s and their underlying ordinaries. To arbitrage, the trader will buy and liquidate the ADR and sell its equivalent in the ordinary on its home exchange, pocketing the difference in the process. They can do it in reverse, depending upon which side is trading richer. The cost to maintain an ADR program can be expensive; therefore, most companies who engage in these programs have long term goals in mind and tend to enjoy financial stability, which is one reason why they are preferred over ordinaries. For a symbol search of American ADR’s go to www.adr.com or http://www.adrbny.com/home_dr.jsp

When considering ADR’s versus Ordinaries you should consider a number of things. Jamie Heller, Editor at Large for TheStreet.com, outlined them quite well in her 2001 article, “What Works: Getting Started at Trading Foreign Stocks”

It is important for Americans to understand that in almost every other country in the world investors can buy foreign ordinaries, or stocks, from a wide variety of countries without jumping through hoops. There are now several companies that can transact foreign ordinaries business in the United States. You can go to E*Trade, Intltrader.com, Merrill Lynch, PaineWebber and Schwab, among others. GNT believes that more brokers will be offering global services in the near future, as mergers bring all sorts of services together to provide global investment. Currently, there are extensive costs to trading ordinaries, although that, too, is changing to the benefit of investors. You have to pay your U.S. broker, which is usually a moderate agency fee, then local clearing fees, local brokerage fees and, usually, local taxes. Investors should also be aware of the currency risk in investing in ordinaries. Although many firms can now settle in your currency of choice, your stock value is still governed by the underlying currency of the exchange it trades on. Obtaining quotes has become considerably easier, including the monitor you can customize on GNT’s website (www.gnta.net) that can support most foreign quotes using Yahoo support. Investors should always keep in mind that trading in any market carries risk, but trading in unfamiliar ground can be treacherous and should be approached with caution. Bank of New York’s ADR Direct is an institutional service that enables investors to buy ordinaries directly from foreign exchanges and then convert them to ADR’s in seconds. Bank of New York has been a leader in developing global trading and custodial services for institutional clients. At some point in the future these types of services will be made available to consumers.

Emerging Markets

Whenever we think about emerging markets, BRICK immediately pops up, (Brazil, Russia, India, China, Korea) but before we examine BRICK, let’s take a look at the “The World in Figures”, recently published by The Economist Intelligence Unit.  There are 12 countries listed as having the highest GDP projections for 2008, although not all of them are reviewed in the global report. Armenia, Azerbaijan, Equatorial Guinea, Georgia, Kazakhstan, Panama, Qatar, São Tomé and Principe and the United Arab Emirates are all listed as the top (GDP) growers, but are not covered in the balance of the article; however, the article lends valuable perspective to those seeking to go global. Investing in emerging markets is a multi-step process, with the first determination focusing on the countries of choice. The broader the economic base of a country, the better the selection of companies available to invest in, the greater the economic strength for those selections to succeed in. The following information was gleaned from the Economist article and sorted to reflect GDP adjusted for inflation (last column)

You will notice that there are some unlikely countries leading the list. Small countries that depend too greatly upon fossil fuel revenues are subject to greater economic risk during petroleum price downswings. Usually, the broader the economic base, the safer the country you chose; however, recent events in the U.S. sub-prime markets triggered a global selloff, as a clear demonstration of how closely global economies are intertwined.  According to SIFMA, global industry revenues exceeded $794 billion dollars in 2006, up almost 36% over 2005. The world’s market cap for equities reached an historical high of $54.2 Trillion in 2006. Annual global trading volume of exchange traded futures grew 33.3% in 2006 alone. BRICK’s (Brazil, Russia, India, China, Korea [South]) securities industry revenues grew 50% in 2006, while the balance of Asia grew by roughly  22%.  By comparison, U.S. securities revenues grew by nearly 36% during the same period.

Table 1 Global Equity Markets Capitalization ($ Billions)

So what does it all mean? In 1980 the United States represented almost 53% of the total market cap and Emerging markets represented 6.79%. Looking at table 1, you will see that in 2006 the U.S. figure has dropped down to 35.84% of the global total, while the emerging markets cap rose to almost 20% of the world total, enjoying over 400% growth in just the last six years. Just as FDI (foreign direct investment) and capital markets have funded much of this growth, opportunities exist for investors in many developing nations around the world, and Global Net Trading will offer services to help you find them.  

In Deloitte’s Economic white paper, “Global Securities Industry Outlook, Issues on the horizon 2007”, they point out that Goldman Sachs has $25 billion in capital to invest in buy-out deals all around the world. Goldman’s timing couldn’t be better. According to Fortune Magazine, dozens of countries have declared their intentions to seek foreign listings by 2008. Global investment opportunities are like water seeking its own level. As profits are realized, they spawn an ever greater awakening to the opportunities that are evolving all around the world at an almost exponential rate. How do we recognize them? Where does the average broker, or the common investor, learn about the trends that are developing in time to take advantage of them?

Global Net Trading was established to create a single source for industry databases, access and familiarization to executing brokers’ and their markets, a library of the events that impact each market and, in general, reliable sources for information that helps us all stay current with the ever changing paradigm of the global marketplace. In this era, the New World order and the mode of wealth creation are knowledge-based and technology driven; therefore, markets must compete accordingly.   

BRICKs

Brazil

While carnival has become a globally recognized celebration of the Brazilian lifestyle and a national icon, it masks the Government’s very determined efforts to move Brazil to the top of the world’s economies. In the short period of time since just the turn of the century, Brazil’s economy has made remarkable gains. Its GDP easily surpasses the $1 trillion mark, making it the largest economy in South America and, arguably, among the top ten in the world. Its industrial sector accounts for three fifths of South America’s entire industrial production. Brazil’s scientific and technological development has improved dramatically, now attracting over $20 billion in FDI annually, about ten times the investment received a decade ago. Earlier this month, Symetrix, A US chip company, announced it was investing $1 billion to make smart cards in Brazil. In space research, Brazil is one of few nations with a launching center, Centro de Lançamento de Alcântara (CLA), designed for light vehicles and geosynchronous satellites, which has resulted in contracts to launch rockets for France, China, Russia and the Ukraine. Much of the success of the site comes from its proximity to the equator, 2°17’ south, which is advantageous to launching geosynchronous flights.

Brazil contains some of the world’s wealthiest deposits of minerals. It possesses the largest deposits of iron ore as well as large deposits of gold and copper. Brazil is not blessed with plentiful fossil fuels to drive its industry, but it has an excess of hydroelectric potential. Unfortunately, part of that potential will threaten the rainforest if brought to reality. Many of Brazil’s rivers wind their way through the rain forest, so damming some of them at the most strategic points will drown some of the richest collections of plants and animals in the world.  One project, damming the Madeira and Xingu Rivers, is estimated to threaten the survival of several species of giant catfish and some 33 endangered mammal species, including the spotted Jaguar, the giant anteater, the giant otter, the giant armadillo and substantial species of birds. While the trade off of the nation’s power needs versus the environment creates enough of a dilemma, the argument becomes a bit more complex when considering that during the summer months the Xingu dries up dramatically and power generation dries up with it. Due to the complexity of the Amazon River Basin, in terms of both the river network and the impact to and from the rainforest from damming, Brazil faces serious challenges in balancing the development of their hydroelectric resource with the preservation of precious ecological resources that could possibly be the source of life giving medicines one day. To further complicate the issue, hydro projects can present health hazards from the spread of disease carrying organisms, like snails (bilharzias parasitic worms) and mosquitoes (dengue fever, yellow fever and malaria). Covering the rainforest with water can also create tremendous amounts of silt that can clog up dams and carbon buildup from decaying biomasses that create greenhouse gases. Given the level of complexities that come with Brazil’s hydroelectric power, the challenges that the country faces create new opportunities for technology to harness the power of its river network.

Brazil is the fifth largest country in the world and benefits from a huge agricultural industry, despite the fact that much of its inland territory is occupied by rainforest. Brazilians lead the world in producing and exporting coffee, sugarcane and orange juice, but they also produce substantial amounts of soybeans, grains, cotton, tobacco and bananas. Although timber is an important national product, much of it is illegally harvested from the world’s largest rainforest, destroying much needed habitat for many endangered species. These species are further endangered by a flourishing illegal wildlife trade that is estimated to remove between 10 and 24 million animals from the rainforest annually, generating hundreds of millions of dollars in black market agro revenue. Brazil’s sugarcane production feeds its massive, globally renowned ethanol fuels program. As Andrew Liveris, chairman and CEO of Dow Chemical, stated, “When it comes to biofuels and related products, Brazil is the leader. The US is thinking about it. Brazil is doing it.” In addition to its ethanol program, Brazil is developing a biodiesel fuel based upon castor beans and soy beans. While this project had a heady start in 2006, the Government’s directive that production come from small family run farms did not provide sufficient raw oil to meet the needs of the program. This is ironic given the fact that Brazil leads the world in soy bean production. The Government has many obstacles in front of it to make this program work. First it needs to educate its peasant farmer masses enough to make them capable of understanding this type of farming. Second, it has to be able to bring them all together in a cooperative program that can scale up production enough to meet demand. To hedge its bets, Petrobras planted large amounts of soy to meet its needs, but a severe increase in global soybean demand forced Petrobras to shelve its biodiesel project for the moment. While this was seen as a failure to some, one must consider that Brazil received top dollar for the expanded soy crop and in October of last year announced the discovery of the largest oilfield found anywhere on the planet. It would appear that despite some adversity along the way, Brazil has many energy options available to it in the future.        

Exports have more than doubled in Brazil over the last four years and its foreign exchange reserves have almost quadrupled during that same period. This comes after a record surplus of $3.04 Billion in July 2006 that exceeded the level most analysts had predicted. Strong economic development is needed for Brazil to offset its rather substantial debt, which remains high at roughly 50% of GDP. Brazil’s central bank is expected to keep its benchmark interest rate at 11.25% for a third straight meeting, according to Brazil Economy Watch, so these financial needs open doors of opportunity for FDI to capitalize on the tremendous growth potential of this amazing country. Brazil benefits from having the fourth largest global airplane manufacturer in Embraer, which was set up as a government company in 1969, but went private in 1994. Embraer (ERJ:NYSE) competes directly with Canada’s Bombardier Aerospace for the regional airline market, which has expanded by 1,000% in Europe and 1,400% in the US between 1995 and 2005. In May of 2006, Embraer launched the Lineage 1000, a business jet based upon its E-190 regional passenger jet, but featuring a substantial 4,200 nautical mile range. This is the largest jet in Embraer’s business line, which is complemented by commercial, military and agricultural lines. Last year Embraer met its goal of producing over 165 aircraft in 2007 by delivering 169 planes. Embraer is now pushing a new class of planes that seat between 70 and 110 people comfortably, because the US Department of Transportation statistics indicate that 61% of all aircraft departures have headcounts in that range.

A key facet of Brazil’s military industrial complex is the submarine building program it began in the 90’s, leading to the production of the “Tamoio”, a Tupi class submarine which was christened in 1997. Since then Brazil has built three more submarines, given the Indian names, “Timbira”, “Tapajos” and the most recent, “Tikuna”, which is also the name for this latest class of submarine in the Brazilian navy. The first three Tupi class boats were built from adaptations of Germany’s IKL-209 model, but were enhanced by Brazilian engineering innovations to improve upon its shot guidance system and electrical energy generation.  They carry a crew of 42 and are currently driven by diesel electric engines, but Brazil has made a commitment of almost half a billion dollars to develop nuclear propulsion systems for their submarine fleet.

When you consider Brazil’s resources, political structure and industry, it is no surprise that it has become the South American focus of many institutional investors. As the leading economic force on the continent, it reflects the continuous balancing act of growing an economy while marshalling incredible resources that are intertwined with extreme ecological complications. 

Russia

According to the Ministry of Natural Resources of the Russian Federation, Russia is blessed with incredible amounts of oil, natural gas, gold, platinum, diamonds, fresh water and other valuable natural resources. Still the country with the world’s largest land mass, despite the dissolution of the USSR, Russia also holds the world’s largest natural gas reserves, at 1,700 trillion cubic feet in proven reserves, the world’s largest diamond and oil reserves and the second largest coal reserves (173 bn. short tons). The U. S. estimates Russia’s Arctic reserves at 100 bn. barrels of oil, although Russia claims only half of that figure. A U.N. Report responds on the water supply that, although Russia has the largest supply of fresh water from lakes in the world, much of that water is polluted and their drinking water is at a crisis point due to the lack of facilities to process it properly.

From aircraft engineering to every type of software programming, Russia has become a global player in labor outsourcing. Despite the misguided belief that telecommunications have made geographic convenience unnecessary in the outsourcing space, the reality is that cultural differences require greater initial personal cooperation and communication between the parties. Both are essential to get things moving properly in the early stages of an outsourcing relationship; therefore, Russia’s depth of technically educated people, combined with a close proximity to Europe, makes it the preferred choice for many European based firms in need of services where personal relationships are essential. Since 1997, industrial competitiveness has improved steadily in the former Soviet Union and has remained encouraging in recent years; however, State run operations still return dismal performances, which reflect poorly on grain processing, bread production and the energy sectors. Even the high tech industry is suffering a crisis that is noteworthy, as reflected in an article printed by Jane’s International Defence Review entitled, “Russian industry hits high-tech low” on 15 January 2008.

All of this considered, capitalism has taken root in Russia and its greatest influence will be from the competitive nature of free markets, which was the predominant characteristic of economic growth missing under communist rule. Free markets breed competition and competition breeds better production. Now that more Russians are enjoying the fruits of a market economy, nothing can put that genie back in the bottle; however, the wild card for investors to watch is the disposition of Vladimir Putin. He may be stepping down from the presidency this year, but all indications are that he is positioning himself for long term control of the country. The question that resides in the back of everyone’s mind is whether or not his tutelage will take the former communist nation back into the dark ages of socialist economics that have proven to be so catastrophic for them in the past, or allow the power of a free market economy to work its magic for his people. With price freezes currently being instituted on foodstuffs to help check inflation, and consumer prices in October up some 9.3% since the start of the year, common sense should point him in the right direction. Investors should expect some bumps along Russia’s road to capitalism. Keep a watchful eye on how Putin steers his country’s role in global politics for signs of a return to the old communist power struggle with the west. Despite his country’s immense wealth in natural resources, that is the one bump that will make the road to economic recovery very difficult to navigate if the west feels the need to contain Russian aggression by containing its economy.

In 2003 a team of Goldman Sachs economists coined the term BRIC for Brazil, Russia, India and China, as an acronym of the world’s strongest emerging economies. The point of the research was that the combined BRIC economies could become larger than the 6 most developed economies in less than 40 years, leading to a profound shift in the balance of global power. Fortune printed an article entitled, “Taking a Brick out of BRIC”, which makes the case that Russia doesn’t belong in the mix and it should be referred to as BIC, for “breakout industrializing countries”. It is a worthy read and provides good insight to the points we have alluded to in this segment of our global review. The last sentence of the article sums it up best, “Yet the Kremlin's political choices are likely to stunt Russia's long-term economic development for many years to come”

India

While India’s GDP is growing almost as rapidly as its northern neighbor, 9.2% in 2006, there is a less restrictive government for outside firms to deal with than China offers, a dynamic that began with economic reforms that reduced government controls on foreign trade and investment that began in the early 90’s. That, in addition to India’s greater number of business graduates every year, provides India with an edge in business development that makes it the preferred choice for long term investment. At its current growth rate, India’s securities trading volume may dominate the global markets by the end of the decade. After tripling in 2005, India’s M&A volume increased another 38% to $27.8 Billion in 2006, further stimulating market activity. Every major Bulge Bracket firm in the world has established wholly owned subsidiaries in India, making competition for local talent the highest it has ever been in the country, leading to staffing problems as a consequence. JP Morgan Chase moved its research facility to India in 2003, like the rest of Wall Street. Why? Because research costs in India now run about 30% of what they run in the States, not including the substantial cost of benefits required in the States. When you factor in the youth of this well educated labor force, it is easy to understand how the evolution of India’s economy should only improve over the next few decades as they gain experience in their vocations.  

Two thirds of India’s population is still involved in agriculture. Strangely enough, agriculture, logging, forestry and fishing account for only 18.6% of the country’s GDP, but take 60% of the population and 43% of its geography. Clearly, this is a country with one sector of its populace moving ahead exponentially faster through education and technology than its larger, less educated agrarian brethren are in the rural areas. There is concern that this dichotomy could lead to social unrest in the country as the two groups grow further apart in economic gain and social development. The rather capricious nature of the monsoon dictates how bountiful the harvest will be in any given year, since irrigation is not as beneficial as it is in other countries. Agricultural programs are controlled at the state level rather than the national level, although the government formulates policy oversight and funding for agricultural programs. State run commodities programs offer some assistance in support programs to farmers, but for the most part the industry functions under the normal market influences. ISAP, the Indian Society of Agricultural Professionals is working diligently to improve the lot of the rural farmer and the industry in general. They provide a wide variety of services designed to disseminate information on how to obtain subsidies, which crops to grow and other market linked exchanges of information to help the farming community. Indiaagronet is another source for the exchange of information for the industry. Farmers can access a wide range of information and services to assist them in growing their businesses, buying equipment, finding jobs or accessing technology. An interesting conundrum is developing for India as its society grows more affluent and the use of fossil fuels drives the need for ever increasing amounts of fuel. Global concern is developing over the amount of acreage that is being diverted to crops used in bio-fuels production, because of the impact it can have on the price of grains as their plantings are reduced, as well as the amount of water needed for bio-fuels production. For the poor of India, many of whom are vegans, this is a dilemma that the country cannot ignore. Given the fact that India has almost as many people as China (85%), but roughly half of the land mass, the density of the population indicates an ever growing need for greater production from the farmland that exists. It is interesting to note that India has one of the largest herds of beef, despite the vegetarian lifestyle of many of its people. The explanation for this lies in the fact that India is the world’s largest producer of milk, with some 40% of India’s farming households, about two thirds of which own less than on hector of land, being engaged in milk production. Asia’s demand for dairy products is growing at a substantial pace, with India’s consumption alone accounting for 50 billion liters in 2007.  

Manufacturing is strong in India. The country anticipates becoming the world’s second largest steel producer, after China, by 2016, followed by Japan and the United States. This demand will be spurred partially by Essar Global’s acquisition of Algoma, which supplies U.S. carmakers with sheet steel and gives India major access to the U.S. steel market for the first time in history. India’s industrial production rose 11% in February of 2007, year over year, driven by increasing consumer demand from its bourgeoning, upwardly mobile workforce. According to a study by McKinsey Global Institute, India’s aggregate consumer spending could more than quadruple to $1.75 trillion, from 2005 levels, by 2025.  India’s huge domestic market, long manufacturing history and education system make it perfect for global manufacturers to expand into, according to Boston Consulting Group. Every industry that requires a skill intensive work force is setting up shop in India, accounting for 40% of the country’s manufacturing output. Manufacturing now accounts for about 20% of India’s GDP, over 50% of FDI and employs 11% of its workforce. Wood and wood products, primarily in the manufacturing of furniture, have grown 62.2% from 2006 to 2007.  

India’s economic rise is driven by its remarkable people and their quest for education. While literacy stands at only 64.8%, the country’s goal of 100% is hampered tremendously by the poverty of its rural areas. In 2003 an estimated 82% of India’s children of primary and secondary school age (6 to14) were enrolled in school. The government expects to make that 100% by the end of the decade. One needs only to witness the clamor of activity around the many used book stalls in India’s open bazaars to recognize the population’s appreciation of knowledge and education.  However, India’s infrastructure is in dire need of modernization for its people to be able to move forward en masse. There is a tremendous need to improve mass transportation, the electric grid and sewage in most of the country. India consists of 28 state governments and 7 centrally administered Union Territories. Described in its constitution as a "sovereign socialist secular democratic republic", India’s national government has extraordinary powers compared to other similarly structured democratic republics. With over 95 languages being spoken and endless numbers of dialects, just governing this huge, incredibly diverse population is a daunting task. To transform it into a 21^st century economic powerhouse will take leadership with tremendous foresight, compassion and patience; however, given the industry of its people and their inherent ability to excel in math and the sciences, there is no doubt they will prevail.  US Companies have saved millions in labor by outsourcing to India. Now, after some 30 years of expanding profits for American industry, the process has come full circle as Indian firms are beginning to invest in America. As the world gets flatter and unit labor costs continue to level out around the planet, Indian entrepreneurs will increase their involvement in the global markets.

China

When the growth of a country leads the world at 7.10%, adjusted for inflation, with a population of over 1.3 billion that enjoy adjusted per capita GDP of only $2,871., it is obvious that an upwardly mobile society must emerge. The question that also emerges with it is whether or not the social structure of China can endure such a dichotomy of the extremes. Concerns have been voiced that the lower classes are being disenfranchised to a point that could produce social unrest. Those issues are not abnormal in economies that grow at such a rapid pace; however, they can be disruptive to the growth process and should be kept in mind when making investment decisions. That being acknowledged, China offers and will continue to offer vast business and investment opportunities for an extended period of time, driven by a massive population seeking a wide range of consumer goods to satisfy its varied social strata.

In 2006 China’s GDP expanded at a rate of 10.5%, fueled by FDI from every major bank on the world. In January of 2007, China’s securities market cap exceeded $1 Trillion for the first time in history. Current Chinese regulatory restrictions place a 33% cap on the equity stake a foreign securities firm can have in industry joint ventures; however, most JV securities firms can’t trade domestic securities. The regulatory climate is becoming more lenient, but in Sept 2006 the Chinese Securities Regulatory Commission announced a temporary ban on investment in the local securities markets. Ultimately, this too will most likely pass; however, the thirst for investment in underdeveloped nations has evoked  global interest that is tracking flatter world development. This process includes nations from every region in the world, so following only the few well known success stories is to deny the global dynamic.

UBS has received licenses to trade, underwrite securities, manage assets and publish research, making it the first full service brokerage in China managed by a foreign firm. UBS will own 20% of this new venture. Unable to enter the industry directly in China, global financial firms have invested more than $20 Billion to acquire stakes in Chinese banks. While encouraging, it is also an indication of how China plans to keep its wealth inside its borders while attracting foreign investment. While critics complain about these restrictions, many of these same people voice concerns about allowing foreign investment in our money center banks, which has not escaped the attention of foreign governments. It makes sense to homogenize corporate ownership among the world’s leading banks so that everyone has an invested interest in each other’s prosperity. When people become overly concerned about the amount of US treasuries that China owns, it is reminiscent of several decades ago when those same concerns were expressed about Japan owning a large percentage of US treasuries. That certainly didn’t hurt the US economy.

The Republic of Korea

When a country of less than 50 million people grows its GDP to over a trillion dollars from a country that is under 39,000 square miles, it is easy to recognize that there is an extraordinary work ethic behind the success story. Korea’s rich and colorful history can be traced back to 2333 BCE, but when the country was split along the politically ideological lines of the United States and the Soviet Union in 1945, South Korea’s legacy began. In 1948 the new Republic was founded, but struggled mightily with the aftermath of 35 years of Japanese control, followed by a vicious three year struggle to remain free of dominance from the north, which was supported by China and Russia. Since 1953, with a nation virtually destroyed by three years of war, South Korea has risen to become what is now the fourth largest economy in Asia. They accomplished this with a population that is only 40% of that occupying Japan and a fraction of the populations of India and China, its closest three rivals in Asian economics. They accomplished this with a land mass that is roughly a quarter the size of Japan’s and under 3% of either China or India. They accomplished this with natural resources that are almost nonexistent, and very limited by comparison to China or India. So what accounts for the incredible growth of this small nation with the tremendous economy? One factor behind Korea’s amazing success story lies in the impact of South Korea’s Chaebols, or business conglomerates.

Chaebols

Often compared to the Keiretsu of Japan, chaebols function in much the same way and have enjoyed similar levels of success, although chaebols do not have a bank at the core of each organization. This last issue has led to reliance upon government support to replace the bank’s role in the keiretsu structure. There are several dozen large Korean family controlled corporate groups that qualify as chaebols. The top four are Samsung, LG, Daewoo and Hyundai, which account for almost 90% of the profits of the top thirty chaebols. All four manufacture consumer electronics and components. They diversify aggressively; but their primary focus began with manufacturing and exporting DRAM’s. Korean strengths in incremental process innovation lend themselves to manufacturing better quality chips. Incremental process innovation is continuous process improvement taken in steps, or increments, and the Koreans are masters at it.  DRAM production is capital intensive, so Government subsidies have  essential to establishing the business; however, trade off to the government is the major DRAM exports that dominate the country’s trade balance. Another way that the structure of chaebols serves its members in launching new products is in financial cross-subsidization, where members of the chaebol help finance the introduction of new products from other chaebol members. Globalization is changing the traditional business relations of Korean chaebols, as they address new market dynamics by embarking on new alliances with non-Korean firms, predominantly Americans, to expand their global influence.

South Korea is the world’s most technologically advanced country in digital communications. They enjoy nationwide HDTV broadcasting, digital multimedia broadcasting to mobile phones (developed in Korea), wireless broadband and 100 Megabit broadband internet access, just to name a few of their technological advances. The position that South Korea enjoys in technology makes it Asia’s poster nation for an advanced modern lifestyle in electronics, which can only lead to greater exports of new products. One of the key components to advances in consumer electronics has been the use of DRAM’s to make them smarter. With their global dominance in DRAM production , Korea has a distinct advantage in new product development for electrical appliances. Their national application of digital technology clearly propels Korea’s development ahead of other nations. Broadband is a clear example of that. In 2003, despite the fact that the entire nation was already wired for broadband, the government and telecommunications industry set in place their plans for a nationwide upgrade to ultra fast 100 Mbp broadband. One reason for upgrading its system was to help government initiatives get more people online to push schools toward making greater use of the network for  research and teaching. As a highly Confucian society, Koreans place tremendous emphasis on education, so government initiatives dedicated to enhancing the national education system are likely to continue as the norm. Korea’s uses of technology in this fashion can only serve to breed even more technological advances that benefit the country.    

Heavy Industry

Korea ranks among the largest of the world’s steel producers. The International Iron and Steel Institute (IISI) stated that in 2007 world steel output reached a record 1.34 billion tons. This is the fifth consecutive year that growth in global steel production has exceeded 7%. As one might expect, China was the lead producer, with Japan and the US following, in that order. China has been the primary driving force behind global production, and without its input, global production of steel would have decreased from 7.6% to 3.3%. According to the IISI, Korea was the 6^th highest global producer of steel in 2007, despite running a trade deficit in steel with China for the year.  

The International Organization of Motor Vehicle Manufacturers states that South Korea ranked fifth in global automotive production, through its five world class automobile manufacturers, Hyundai, Kia Motors, GM Daewoo, Ssang Yong Motors and Renault Samsung Motors. KAMA, the Korean Automobile Manufacturers Association, reported that Korea and the United States signed a Free Trade Agreement on June 30^th of last year, which can only help sales of Korean vehicles in the strong US automotive market.

Seven Korean shipbuilding companies are major competitors on the world’s oceans. As expected, many of the leading chaebols participate through subsidiaries, including dominant players Hyundai Heavy Industries, Daewoo, Samsung Heavy Industries, STX Shipbuilding and Hyundai Mipo Dockyard. There are three main categories for their products, from commercial ships like gas carriers, tankers, containers and passenger ships, to offshore and plant vessels, like fixed platforms for oil and gas drilling. The third category is military ships for the navy, including  submarines, destroyers and battleships. Of the group, Daewoo produces most of the vessels for the oil industry, but they have all done well in general. In 2005, London based shipbroker Clarkson PLC announced that 7 Korea shipbuilders ranked among the world’s top ten, with Hyundai Heavy Industries topping the list..

If there is one potential Achilles Heel in the economic body of Korea, it lies in its agricultural program. In the 20 years from 1984 to 2004, Korea’s agricultural has grown, but seriously lagged behind other industry sectors. It represented almost 15% of GDP 24 years ago, but has declined to 3.2% of GDP just three years ago. During that same period, the agricultural labor force has declined by 75% from 32% to less than 8% in 2004. These figures can be misleading because the balance of GDP sectors have grown at such a substantial rate that comparisons to agriculture make it look like it is not keeping pace with the country’s needs.  The country suffers from having only 22% arable land for farming and less essential rainfall than its other rice growing neighbors. Farmland is continually being lost to industry and residential housing, further diminishing the contribution of agriculture to total GDP stattistics. Farming in Korea is carried out on farms that average less than 1½ hectares in size. Although small scale farms of ½ hectares or less have increased in numbers, agricultural output kept pace through larger farms. Due to the older median age of Korean farmers, this trend is expected to change as aging farmers retire and their ownership gravitates to large scale operations. Rice still dominates agricultural production, followed by livestock products like pork, beef and milk, but this too is changing as the national income increases, affording Koreans more livestock and fruit products in their diet. Cooperatives have been integral to Korean farming since 30 BC, and in the last 30 years the cooperative movement has changed distribution dramatically in Korea, leading to less intermediary marketing and more direct delivery from farmers to consumers. This was accomplished through a direct sale system using warehouse discount supermarkets. Nonghyup, the Korean agricultural cooperatives, have advanced the efficiency of farming distribution and direct delivery to consumers at lower prices, while maintaining the same pricing to farmers. Korea’s agricultural industry will continue to be challenged to ensure food security for the country; however, the percentage of Korea’s population engaged in farming is still larger than in many other nations, where larger, more productive farms have prevailed over smaller, more numerous producers. As the trend toward larger, more efficient operations continues in Korea, it is expected to keep up with the needs of its people.

Deciding where to place international investments will continue to challenge investors as changes take place around the world and various economies emerge with dominance in products or services. In the case of South Korea, the advances in digital telecommunications and DRAM production, plus the options in their auto and shipping manufacturing offer a wide variety of investment opportunities. Korea’s economic success overshadows the diminutive size of this Asian Tiger and clearly indicates why it is the darling of cross border investors.

Conclusion

We have barely scratched the surface of the emerging countries of the world in this article. Yet we hope that we have provided the right incentive to visit this site for additional articles that will help investors of all types to increase their awareness of the global marketplace and the investment opportunities they provide.