SEOUL – 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% 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%, on average) on education. With households already saving only around 4% of their disposable income, compared to 20% 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% 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 US.
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% 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%. Public debt in Japan, by contrast, exceeds 220% 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% by 2030, when 36% 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% 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.