TOKYO -- Uncertainty has been infecting South Korea's market ever since a long-standing spat with Japan blew up into a trade war earlier this year.
At an investor forum last month in Seoul, a European executive was asked for an opinion on South Korea-Japan tensions. The executive said South Korea is in jeopardy of losing its standing as one of Asia's few countries with a clear political outlook. South Korea, the executive added, requires a quick course reversal.
The Seoul stock market has been recovering since mid-August, as have other key markets, but the recovery has been slower than those in Japan and China (South Korean and Chinese stocks had been increasingly mirroring each other during the past few years).
The country's currency has been losing value. On July 31, it took 1,188 South Korean won to buy a dollar. In the middle of August, it took 1,224.
Japan made the first move in the trade war by tightening export controls. One of South Korea's countermeasures was to pull out of a military information sharing agreement with Japan. It later filed a complaint with the World Trade Organization.
Political certainty is the No. 1 factor that investors and businesses look at before deciding whether to put their money into a country. On this front, South Korean politics over the past three months has grown murkier. The latest blur was the appointment of scandal-ridden Cho Kuk to justice minister.
What is going on? South Korea's Confucianist capitalism is showing its limitations.
Sometime around the 14th century, a unique strain of Confucianism began developing on the Korean Peninsula, one that still strongly influences people's lives.
The yangban, the past ruling social class that propagated Confucianist teachings, never took artisans seriously. So skills received no respect and were given over to servants to perform.
Now yangban culture is keeping South Korea's component manufacturing industry weak. This is especially true among small to medium-size companies.
When the country rebuilt its manufacturing industry after the Korean War in the 1950s, it relied on Japan for components and materials. After that, Korean Chaebol, the yangban for industry, demanded that subcontractors cut prices and neglected to nurture technological innovations.
South Korea's economy grew thanks to semiconductor and auto exports, but the nation's trade deficit with Japan grew as it remained dependent on Japanese technology. When Japan earlier this year tightened controls over exports to South Korea, it exposed this inconvenient truth.
The scandal involving Cho also recalls a dark period from when Confucianist culture was at its peak. It used to be that only individuals from the yangban were allowed to take exams for jobs as bureaucrats. The haves were entitled to have more, while the have-nots were left behind.
Even today, a similar gap in social status remains. The wealthy may buy a house in a high-class residential area with a famous cram school nearby. Their children go to prestigious universities and join Chaebol upon graduation. Cho angered people because he is suspected to have used his official position to gain a backdoor entry to university.
South Korean President Moon Jae-in appears to have realized the institutional problem of Confucianist capitalism. To engineer a shift from importer of important products to maker of them, Moon came out with a series of policy measures to support domestic industry. The most prominent goal of income-led growth is to achieve growth by rewarding low-income earners, thus narrowing the country's wide income gap.
But Moon's measures have left some experts skeptical. Chin Dae-je, who drove Samsung Electronics' growth as a key technologist in the 1990s, told a local newspaper that South Korea might never be able to domestically produce semiconductor materials that are of the same quality as Japanese products. According to this view, the technological gap is so wide South Korea likely will never catch up with its neighbor.
The stock market has frowned on Moon's policy to seek income-driven growth because the centerpiece of the policy is a minimum-wage increase.
Smaller companies, which typically pay low wages, are especially vulnerable to labor cost increases. Of companies with annual revenue up to about 10 billion yen ($93 million), selling, general and administrative expenses increased sharply in relation to revenue in 2018, when the minimum wage was raised by 16%.
Labor costs make up a significant component of administrative expenses.
In the aggregate, these companies fell into an operating loss.
The SGA expenses to revenue ratio for companies with annual revenue exceeding 10 billion yen remained largely unchanged, though it rose in the first six months of this year. For the same period, these companies' operating margin fell to 6.2% from 7.8% in 2018.
South Korea's potential growth rate has halved in about two decades to the 2% range, while the country's birthrate has fallen below 1%, making it certain that its working population will start shrinking before long.
There are legitimate concerns that the nation's growth trend could gradually sink toward zero if productivity also falls.
Market concern about South Korea's mounting economic woes has yet to manifest itself in a pronounced way because the country's leading companies boast solid financial footing.
Samsung Electronics' market capitalization, for instance, is the third largest among Asian companies, surpassing Japan's biggest, Toyota Motor.
There are few stocks with such a high degree of liquidity in any country. But that is not to say investors are likely to remain confident about putting and keeping their money in South Korean shares.
A growing number of international investors are growing uneasy about betting on the country's economic future.
If South Korea's economy comes undone, Japan, which relies on its neighbor for 7% of its overall exports, will take a sizable hit.
It will be hard for Japan to cushion the impact by ramping up exports to other countries or by goosing domestic demand now that the global economy is on the brink of a major downturn and Japan itself has raised its consumption tax by 2 percentage points to 10%.
Both South Korea and Japan need to make crucial policy decisions, ones with huge implications for their economic futures: continue with their lose-lose game of chicken to placate public sentiment or restore a win-win economic relationship based on healthy diplomacy that would allow each partner to buy time for necessary structural reforms.
Money pays no attention to the emotional factors behind a country's economic performance. It simply follows economic growth wherever it is.