South Korea's recent economic performance has been disappointing. After 40 years of astonishing 7.9 percent annual GDP growth, the average growth rate dropped to 4.1 percent between 2000 and 2010, and has stood at a mere 3 percent since 2011. This has many wondering whether South Korea is headed for the kind of protracted deflation and stagnation that characterized Japan's "lost decades," from which it is just beginning to emerge.
The similarities between South Korea today and Japan 20 years ago are undeniable. And, in fact, on economic matters South Korea has, for better or worse, often followed Japan's example. In this case, Japan's example can save South Korea — if, that is, South Korea's leaders take it as a lesson in what not to do.
Japan's woes are rooted in real estate and equity bubbles, which were fueled by monetary expansion aimed at stimulating domestic demand after the 1985 Plaza Accord drove up the yen's value and hurt Japan's exports. In the early 1990s, the bubbles burst, leaving the private sector with a huge debt overhang. Add to that sluggish productivity growth, weak demand and rapid population aging, and Japan's situation was dire.