GUATEMALA CITY — Despite numerous economic stimulus packages during his tenure in office, South Korean President Roh Moo Hyun must regret his promise to oversee annual economic growth of about 7 percent during his five-year term. As it is, the South Korean economy grew in the first quarter of 2005 at the slowest pace in almost two years with GDP increasing by only 2.7 percent from a year earlier, the slowest rate since the third quarter of 2003. The economy also failed to meet expectations in 2004 with economic growth of only 4.6 percent.
Finance and Economy Minister Han Duck Soo continues to issue upbeat messages about economic growth. But his optimistic remarks have not improved a souring sentiment among South Korean consumers or businesses. According to a report from the Federation of Korean Industries, most of the 720 traditional shops surveyed did not expect their business to improve in the coming months.
There are reasons to worry that the South Korean economy might emulate its Japanese counterpart and enter into a long slump. For example, South Koreans face heavy debt burdens related to the credit-card bubble that peaked in 2003 and a low rate of job creation. And there is the specter of rising consumer prices following the increase in commodity prices by 5.1 percent in April from a year earlier.
These problems are bad enough. But there are more. For example, China’s attempts to rein in its overheated economy along with further expected increases in U.S. interest rates may cause South Korean export growth to falter. With its economic growth depending more heavily upon exports than Japan’s, South Korea’s domestic demand is even more sensitive to export income. This is all the worse given that many of South Korean exporters enjoy little pricing power.
South Korea’s political leaders response to the disappointing economic growth figures have involved a series of ill-advised decisions that are likely to make matters worse. Instead of shaping policies that address structural deficiencies in the domestic economy, they have been focusing upon tweaking cyclical variables.
Recently, the government front-loaded its spending in the first half of the year, while the central bank froze its key interest rate at a record-low 3.25 percent. Such steps are misguided and likely to prove to be counterproductive. This is because the problems facing South Korea’s economy are long-term and structural, and will require a considerable amount of restructuring.
While South Korea’s central bank has introduced distortions into the real sector by holding interest rates down for a long time, increased government deficits have led to increased public-sector debts and a rising tax burden. Since deficit spending has such a poor record for inspiring corrective measures for cyclical downturns in economic growth, these decisions suggest that short-term political concerns are being placed ahead of long-term economic considerations.
Japan’s economy faces the same structural dystopia as does South Korea’s. And the application of conventional macroeconomic tools has failed spectacularly in both cases. Despite massive runups of massive public-sector deficits with an ultra-loose credit policy, Japan’s economic growth remains feeble.
One of the crucial elements for restructuring Japan’s and South Korea’s economies is that small and medium-size enterprises must gain access to more capital. Both economies will grow slowly until a new entrepreneurial class can act as the basis of future economic growth.
Since bank lending in these countries can be influenced by political concerns, politicized decisions on capital formation is at the core of the financial-sector problems in both South Korea and Japan. In the end, the high levels of personal savings in both countries have been squandered by massive inefficiencies in domestic financial markets.
But all is not lost. South Korea can escape the ravages that were inflicted upon Japan’s economy if policymakers in Seoul grasp the importance of improving the functioning of domestic capital markets. This will reduce the reliance of business investments upon bank financing and represent an important step toward necessary restructuring of the economy.
Many existing inefficiencies in South Korea’s financial system could be corrected if there were better-functioning domestic capital markets wherein stock and bond markets were wider and deeper. As it is, capital markets involve greater transparency and accountability that tend to minimize the likelihood of massive failures.
Another move would involve initiating changes in South Korea’s corporate and political cultures. The aim should be to encourage a new batch of young entrepreneurs to undertake initiatives that are necessary to boost economic growth.
Restructuring in the future must go beyond cutting costs that only correct temporary difficulties. Proper restructuring requires a dynamic perspective that involves deep reform of management practices. This would shift the focus of managers and directors toward maximizing shareholder value through the constant quest to achieve each company’s comparative advantage and invest Korea with an improved overall competitive advantage.
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