[Production Costs Soar] ① Up 8.7% in the First Half of This Year... Increasing North American Investment Due to IRA, but Exchange Rate Hits 1,400 Won

4.6 Times the 10-Year Average
Wage Increases, Raw Materials, and Exchange Rates Main Causes
Significant Rise in Manufacturing Production Costs
Difficulty Reflecting Increased Costs in Product Prices

The production cost increase rate for companies in the first half of this year reached 8.7%. This is the highest rise since the financial crisis when it recorded 10.8% in October 2009. [Related Article] Production Costs Break the Ceiling

According to the "Estimation and Implications of Corporate Production Cost Increase" published on the 23rd by the Korea Chamber of Commerce and Industry's SGI (Sustainable Growth Initiative), the average production cost increase rate across all industries over the past 10 years (2011?2021) was 1.9%, which has now risen approximately 4.6 times. The production cost increase rate was calculated using a price transmission effect model linking industries, based on the year-over-year changes in factors such as raw materials like crude oil, iron ore, copper, aluminum, the won-dollar exchange rate, and wages. Breaking down the production cost increase rate by production factors, wage increases had the largest impact at 3.2 percentage points out of the total 8.7%. Raw materials contributed 3.0 percentage points, and exchange rates 2.5 percentage points.

In particular, the manufacturing sector, the largest pillar of our economy, showed a greater increase in production costs compared to the overall industry. Manufacturing requires a large amount of imported raw materials such as crude oil and iron ore during production. Manufacturing production costs increased by 10.6% compared to the same period last year, surpassing the service sector's 6.6% increase.

Within manufacturing, production costs rose significantly in petroleum refining (28.8%) which uses crude oil as the main raw material, chemicals (10.5%), and non-metallic minerals (9.7%), primary metals (8.2%), and metals (7.2%) that use minerals such as copper, aluminum, and iron ore as intermediate inputs.

This increase in corporate production costs worsens profitability in the short term, but if this trend continues long term, there are concerns about a decline in corporate competitiveness. Due to inflation and the resulting global economic slowdown, companies find it difficult to devise exit strategies. Especially amid ongoing changes in the global industry triggered by the implementation of the U.S. Inflation Reduction Act (IRA), it is challenging to adopt passive investment or production strategies citing cost burdens.

The won-dollar exchange rate surpassing 1,400 won for the first time in 13 years and 6 months is also a warning sign for our economy. The market evaluates that the usual formula where exchange rate increases benefit export companies will differ in this crisis. Typically, when the exchange rate rises, the won depreciates, enhancing the price competitiveness of Korean exports and increasing sales revenue in won terms. However, recently, as domestic companies have built factories overseas to increase production and sales, they are less affected by exchange rate fluctuations. Moreover, the sharp rise in raw material prices has worsened profitability, causing more side effects. The global economic slowdown also makes it difficult to fully reflect the increased raw material costs due to exchange rate hikes in product prices.

In fact, LG Energy Solution, a battery company that had been aggressively investing in North America and Europe, is reconsidering its U.S. investments. In March this year, it announced a 1.7 trillion won investment to build a new cylindrical battery plant with an annual capacity of 11 GWh in Arizona, but in June, it began a full review. Within just three months, inflation, high exchange rates, and rising interest rates caused construction and logistics costs to surge.

Kim Cheon-gu, a research fellow at the KCCI SGI, said, "The current increase in corporate production costs is largely due to macro-environmental changes, making it difficult for individual companies to respond. It is a time when not only internal cost-cutting efforts by companies but also active government support are necessary."