SEOUL — Few top economies are as surrounded by paradoxes in 2026 as South Korea.

As fallout from the Middle East sends shockwaves around the globe, Korea’s stock market is skyrocketing. This week, the Kospi index soared to new all-time highs as semiconductor giants Samsung and SK Hynix ride the artificial intelligence boom.

Making your way around Seoul, it’s easy to buy into the euphoria. Countless global conferences herald Korea’s place in the AI era. Across the city, young executives hover around laptops in WeWork-fashioned shared office spaces — the more tie-less, the better.

Under this thick layer of economic energy lurk reasons to worry. Many, in fact, as China grabs more and more global market share and Korea’s economic ties with the US crumble in real time.

These underlying frailties are easy to compartmentalize. The wonders of the AI boom and K-Pop world domination are topping the news cycles — and captivating the broader zeitgeist. Yet global investors might do so at their own peril.

Those preexisting conditions include: a rigid corporate system dominated by a handful of family-owned conglomerates, dangerously high household debt, lackluster productivity, uncompetitive labor markets, and one-time industrial strengths that China is increasingly luring its way.

For all China’s troubles, its rapid growth and scale are commoditizing — or in the process of doing so — much of what Korea has long done well: cars, electronics, semiconductors, robots, ships and popular entertainment. Not just on price, but also on innovation with its own supply chains.

For less developed economies in Southeast Asia, the next China shock will be mass deindustrialization. Korea is hardly immune, as Chinese electric vehicle makers like BYD remind Korea that complacency can be very expensive.

Here, the “Made in China 2025” economic moonshot that Xi Jinping launched a decade ago is gaining traction in ways Korea Inc. is only now confronting. The advances China Inc. is making in AI, EVs, batteries, drones, biotechnology, renewable energy, and other future technologies pose a greater threat to Korea’s future than Donald Trump’s tariffs.

To be sure, Trump’s policies are a clear and present danger to Korea’s outlook. But Trump will leave the scene at some point. China’s growing tech prowess, underwritten by vast state subsidies, is likely to persist.

The Chinese Communist Party’s latest Five-Year Plan for economic development promises even greater state support for advanced industries to strengthen the economy’s capabilities. And position China for the world it will confront in 2030 and beyond.

This isn’t to discount Korea’s potential. Investors who’ve bet against Korea in recent decades haven’t made a lot of money. Korea, after all, is an economy that can take a serious punch.

Following the 1997-1998 Asian financial crisis, Korea was the first economically shattered nation to recover. A decade later, Korea navigated around the “Lehman shock” in ways hedge funds didn’t expect. In 2009, Korea failed to become the “next Iceland,” as markets had speculated.

Korea sailed through the Federal Reserve’s 2013 “taper tantrum,” which rocked developing nations everywhere. Ditto for the Trump 1.0 trade war from 2017 to 2021. In 2020, Korea served as a Covid-19 role model, with low infection rates. Then in 2021, the Bank of Korea was the first top-12 central bank to tighten policy.

More recently, Korean President Lee Jae Myung managed to navigate the Trump 2.0 reality show of 2025 and trade war comparatively well. And today, the Kospi index is hitting all-time highs despite Trump’s tariffs and the US-Israeli war in Iran.

The problem, though, is that Korea is highly skilled at economic defense but not always great at offense. In 2026, both skills will be very important.

So is convincing the world that Korea isn’t losing its innovative mojo. Korea seemed to be at the center of the tech universe when tech equaled cool smartphone models. Today, the metric is not just manufacturing high-end chips for AI. It’s inventing new game-changing tech that puts Korea at the center of global disruption.

Arguably, proactively strengthening Korea’s competitiveness game is even more important amid Asia’s start-up arms race.

A major structural problem in Korea is that the sprawling conglomerates tower over the place. These “chaebols” hog much of the economic oxygen needed to nurture new and innovative companies to grow to mid-size status. In top-down economic systems, true disruption typically only occurs when a startup reaches a certain scale.

On April 16, Lee urged Korea Inc. to accelerate its move upmarket. “The global trade order is at a critical turning point amid the decline of free trade and intensifying geopolitical risks,” Lee said. “For a country like ours with a heavy reliance on manufacturing, we must undertake bold and transformative innovation with the nation’s future at stake.”

That’s easier said than done. Korea doesn’t have to go the China route with massive government subsidies. But Team Lee should be playing a leading role in incentivizing the research and development, ecosystems and risk-taking ethos needed to put Korea at the center of influencing the direction of the AI wave — not just riding it.

No doubt, Lee’s 324-day-old administration is on something of a roll. In the weeks before he took power, Lee promised to end the “Korea discount” that had long left the market undervalued relative to peers.

He pledged to more than double the Kospi index to 5,000 within five years (it was just under 2,500 then). Thanks to the global AI trade, it took just five months. In February, Korea’s overall market capitalization surpassed those of both France and Germany.

Last week, the Kospi index surged to an all-time high above 6,400, up 160% over the last 12 months. The trouble is, Korea could be the vanguard of collapsing asset markets if the AI boom ends badly. So far, the AI trade has made things easy for Lee’s government. A messy reversal could slam Korea Inc.

Another problem is Korea’s relatively low place in the MSCI universe. For roughly 20 years, Korea has been angling for an upgrade to developed-market status. It would lure tidal waves of global capital into won-denominated assets.

MSCI continues to say no. It wants Seoul to scrap outdated regulations, loosen limits on corporate ownership, strengthen capital markets, increase currency-trading hours and boost transparency. To Seoul’s credit, lawmakers acted in March 2025 to resume short-selling, ending a 17-month ban. Seoul also increased foreign exchange trading hours to 17 hours.

In June 2025, when it rejected Korea’s upgrade request again, MSCI said: “Despite these reforms, investors believe it remains critical to assess whether the implemented measures are sufficient, given that developed markets typically feature fully convertible currencies with active, unconstrained offshore and onshore forex markets.” Translation: let us know when you act on these pledges.

Now for the good news: Korea’s parliament just approved a long-debated measure demanding that companies cancel so-called treasury shares. These shares, which don’t receive dividends or voting rights, are used by chaebols to avoid hostile takeovers. Eliminating them has long been key to ending the Korea discount.

Lawmakers also claim that more reforms are on the way. Yet the discount problem is much bigger. It’s also vital that lawmakers take strong, transparent antitrust actions to reduce the dominance of the family-controlled conglomerates.

Yet Korea has lots more to do to ensure the enthusiasm for won-denominated assets doesn’t turn out to be irrational. His predecessor, Yoon Suk Yeol, sought to strengthen Korea’s capital markets from May 2022 to late 2024, when his martial-law stunt brought down his presidency.

While in office, Yoon’s Financial Services Commission unveiled a “Corporate Value-Up Program” to prod Korea Inc. to boost efficiency, diversify boardrooms and increase shareholder returns. Although Yoon didn’t name-check Japan, his sudden push to strengthen governance came the same week the Nikkei 225 Stock Average was topping 1989 highs.

Japan’s stock rally comes after 10 years of efforts to prod CEOs to increase returns on equity and give shareholders a bigger voice. Just this week, the Nikkei briefly topped 60,000 for the first time.

Seoul’s desire to ride Tokyo’s coattails makes eminent sense as it takes a swing at ending the “Korea discount” once and for all. And the effort is paying off, with attention from global investors on the rise.

“Corporate governance in South Korea has become an investment opportunity,” says Bob Herr, director of corporate governance at Alliance Bernstein.

“Since 2024, the government has used persuasion and legal pressure to improve governance in several areas, including capital allocation and protection of minority shareholders. The results have been positive, and we see potential for further gains. The best way for investors to capture these, in our view, is through a combination of fundamental research and proxy voting.”

Seoul National University economist Keun Lee argues that the Kospi’s gains are about more than government initiatives. The boom is also being driven by the rapid rise of individual investors, which is upping the pressure on Korea Inc.

“These developments imply a fundamental change in the nature of South Korean capitalism,” Lee notes. “The foreign investor-based system that emerged after the 1997 Asian financial crisis – supplanting the domestic corporate-shareholder-based system that previously prevailed – has now been replaced by a system dominated by individual investors. Whereas the old corporate-shareholder-based model emphasized the reinvestment of profits to support the company’s continued growth, the new one encourages the delivery of short-term shareholder benefits like dividends.”

Unfortunately, though, Korea’s strategy to keep up with the bulls lacks specifics or a discernible timeline. Hence, MCSI’s glacial pace in raising Korea into its orbit of developed markets. And hence, very valid questions about whether Korea can lead in the AI age, not just participate in it.

As the Kospi zooms higher and higher, Korean leader Lee risks letting today’s irrational exuberance get away from him. He also risks tempting a Wile E. Coyote moment in Asia’s No. 4 economy.

Follow William Pesek on X at @WilliamPesek