Korea Breaks The Mold; For a country nearing a per capita income of $20,000, the sclerotic service sector is a major anomaly. And it may explain the slowdown.

Byline: Ruchir Sharma (Sharma is the head of emerging markets at Morgan Stanley Investment Management)

During the boom years in east asia, the economy and the stock market were distant cousins. A case in point was South Korea, where the benchmark KOSPI index peaked in 1989, while the economy continued to grow at an 8 percent pace until the outbreak of the Asian financial crisis in 1997. Critics said Asian corporations were too inefficient and poorly managed to capture theeconomic story. Now it seems South Korea is turning the Asian model inside out.

Growth in the economy has slowed to 4 percent, but the stock market has risen eightfold in dollar terms since bottoming out in 1998. South Korea is the only East Asian emerging market to have hit all-time highs since the financial crisis. Korean conglomerates now understand the importance of adding economic value by investing extensively in research and development; the country's R&D expenditure as a share of the economy is one of the highest in the world, at 2.6 percent of its gross domestic product. The focus on investing in technology and building global brands now distinguishes Korean companies from Asian counterparts that are still stuck in low-margin contract-manufacturing businesses. Once again, however, the rise of Korea Inc., to the exclusion of the rest of the economy, could end up being problematic.

First, the good news. South Korea has been one of the largest recipients of foreign portfolio flows in the current emerging-market bull run, even though its economy hasn't participated in the boom. Korean conglomerates have become growth plays, and are benefiting from their pioneering moves into fast-growing markets like China and India. South Korea's economy is even more closely interlinked with China than with the United States. A furious pace of outsourcing by South Korean companies has also helped raise the rate of overseas investment as a percentage of Korea's GDP to 7 percent.

But herein lies the problem. It seems the only way to succeed is to go abroad, and not just for corporate jobs. The ratio of domestic fixed investment to GDP is falling. Angst is rising at home as jobs move abroad. The country is running a deficit of $20 billion ...