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South Korea’s Japanese mirror

by Danny Leipziger

Given the daunting challenges facing Japan, one can only admire Prime Minister Shinzo Abe’s determination to end the country’s two-decade-long period of economic stagnation. His strategy — the “three arrows” of massive monetary expansion, increased government spending, and structural reform — is theoretically sound. But only one and a half arrows have been launched so far.

The stimulus package is being offset by consumption-tax hikes aimed at reducing Japan’s massive debt burden — a process that will lead many Japanese consumers to adjust their spending downward.

The promised structural reforms of the energy sector, labor market, and competition policy have yet to be introduced, and appear unlikely to take effect anytime soon. Even more worrisome are larger immutable realities — like a rapidly aging and shrinking population — that will limit Japan’s economic growth in the coming decades.

But Japan’s problems are not unique. Indeed, its neighbor and historical rival, South Korea, is headed down a similar path. The difference is that South Korea may still have time to ameliorate these trends, and avoid a Japanese-style quagmire of permanent low growth and long-term decline.

South Korea — the seventh-largest trading country in the world, and one of the most prominent economic success stories of the last 50 years — is at risk of such a bleak future as a result, first and foremost, of demographics. South Korea’s working-age population is falling by 1.2 percent annually — the fastest decline among OECD countries.

While there are many reasons for South Korea’s low fertility rate, two economic factors stand out. First, household-debt levels are enormous, capturing a quarter of income, with mortgage payments taking the lion’s share. The ratio of housing prices to incomes is more than double that of the United States.

Second, South Korean families feel compelled to spend a large share of their income (10 percent, on average) on education. With households already saving only around 4 percent of their disposable income, compared to 20 percent in 1988, there is little room for additional expenditure.

A concomitant feature of South Korea’s labor market is that women’s labor-force participation rate — a paltry 33 percent for women aged 30-39 — is among the lowest in the OECD. This partly reflects the difficulty of balancing child rearing with work in South Korea, compared to, say, Europe or the U.S.

South Korea’s female labor-force participation rate is even lower than in Japan, where there are waiting lists for childcare. Moreover, South Korea has underinvested in day-care centers, with firms rarely offering childcare support. Given that South Korean women tend not to hold lucrative jobs, the cost of childcare is often prohibitive.

The recent increase in South Korea’s minimum normal retirement age has done little to improve the labor-market outlook. Wages in the small and medium-size enterprises (SMEs) that employ 88 percent of workers still lag behind those of major conglomerates, the chaebols; and the middle class is shrinking in terms of its share of earnings.

But South Korea does have some advantages over Japan. Although the government’s stimulus policies have increased the national debt, the debt/GDP ratio remains relatively low, at roughly 37 percent. Public debt in Japan, by contrast, exceeds 220 percent of GDP.

Moreover, despite South Korea’s dependence on exports, domestic consumption is robust. And ample spending on research and development, together with an unrelenting drive to be at the forefront of technological innovation, implies a brisk pace of innovation. This creates room to address one of the economy’s two main challenges: low productivity in services.

As it stands, productivity in services is six times lower than in manufacturing. The operations of South Korea’s chaebols — which dominate production, if not employment — should be adjusted to support productivity gains in the increasingly dominant services sector.

The key here, as in Japan, is to foster greater competition in services. If the chaebols continue to do their own advertising, financing, and IT, they will starve SMEs. A review of industrial concentration is warranted, as is a major government effort to foster SME growth in new ventures by offering incentives, ensuring access to capital, and lowering barriers to market entry. More employment in higher-end service jobs, especially for women, would also improve South Korea’s prospects considerably.

In the longer term, however, South Korea’s prospects hinge largely on the labor force. The rising dependency ratio — expected to exceed 50 percent by 2030, when 36 percent of the population will be above the age of 65 — could spell disaster for the country. Health care costs will rise, increasing the strain on budgets. While increased immigration could help to ease labor-force pressures, it would be met with public resistance. In this context, potential growth may well fall back to the predicted 2.5 percent annual rate, even though the economy’s capital stock is in good shape.

South Korea has learned numerous positive lessons from Japan. It captured many of Japan’s export markets; it imported and adapted Japanese technologies; it employed similar planning methods; and the chaebols are an outgrowth of Japan’s zaibatsu corporate model.

Now, however, South Korea must learn from Japan’s negative experiences. Structural reform cannot wait. Nationalism should be channeled toward securing public support for deep economic and social reforms.

South Korea’s leaders do not have to look far to find out what will happen if they fail to address looming challenges quickly and resolutely.

Danny Leipziger, a professor of International Business and International Affairs at George Washington University, is managing director of The Growth Dialogue. © 2014 Project Syndicate (www.project-syndicate.org)

  • phu

    “Nationalism should be channeled toward securing public support for deep economic and social reforms.”

    This is one of the most, if not the most, insightful and constructive statements I can remember having ever read regarding these reforms.

    Right now nationalist zeal is being stoked for exactly the opposite reason: To enable politicians to ignore these genuinely difficult issues. If the Japanese and South Korean governments actually turned that inward and spoke to national pride as a reason to improve their human infrastructure, instead of a few flimsy arrows, Abe could have acres of lumber; why shoot at targets when your real goal is to build something?

    Also, the whole “global stability” thing would be helped a lot if even just two nations stopped taking never-ending cheap shots at each other for no productive reason.

  • wangkon936

    Mr. Leipziger makes a lot of excellent points. Today’s problems in Japan will be tomorrow’s problems in Korea. Korean followed Japan’s post war modernization model and will thus inherit its problems, unless it does a number of tangible things to avoid them. However, before Korea and Japan can work together more closely and even be formal allies, the historical issues must be dealt with. Korea and Japan’s mutual historical issues are not as much of a political red herring as Leipziger thinks. There are tremendously deep grass roots forces in Korea and even in the Korean diaspora, as the comfort women statues going up in California, New Jersey and New York will attest. There will be no chance of rapprochement and cooperation until there is mutually agreeable dialogue leading up to forward movement on this matter. The Japanese must make satisfactory efforts to resolve the historical issues. At least from the Korean side, this is a non-negotiable matter.