Monday, November 24, 2014
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Renewing the South Korean Miracle

SEOUL – South Korea’s incoming president, Park Geun-hye, takes over a country that has been a global role model for economic development. But, with the economy slowing, it has become a model in need of renewal.

The so-called “Miracle on the Han River” took root with the reforms initiated by Park’s late father Park Chung-hee, the country’s ruler for much of the 1960’s and 1970’s. A measure of South Korea’s success is that it was the first country to make the transition from being a recipient of OECD aid to becoming a donor, with per capita GDP today exceeding $30,000 (in purchasing power parity terms).

But the growth formula that long underpinned South Korea’s success – a form of state-guided capitalism that focuses on export-led manufacturing – is no longer working for many South Koreans. GDP has nearly tripled over the past 20 years, but, with real wages rising at less than half this rate, growth has become decoupled from the fate of ordinary citizens.

More than half of middle-income households spend more each month than they earn. The signs of social distress are multiplying. South Korea’s divorce rate has doubled, fertility rates have fallen to the fourth lowest among advanced economies, and the suicide rate is the highest in the OECD.

South Korea is troubled for two key reasons. First, although some parts of the economy reached advanced industrialization in record time, other parts (and institutions) are struggling to catch up. Manufacturing conglomerates such as Hyundai, LG, and Samsung have morphed into highly productive global giants whose growth creates fewer high-quality jobs at home than before. Employment at the country’s largest companies is falling, and the share of South Korean jobs at such companies has dropped by one-third since 1995.

But South Korea does not have a well-developed service sector to provide a new source of high-paying jobs. Worse, service industries are falling further behind large manufacturers in terms of productivity and wages.

This leads to the second challenge: the dire financial straits of middle-income households. Many families now face stagnating wages, owing to the kinds of jobs now available, but are determined to cling to a lifestyle that they can no longer afford. Families with children are engaged in an escalating “educational arms race,” devoting large shares of their income to private education and tutoring to prepare children for entrance to elite universities and a shot at a secure job at a major corporation.

Middle-income families also insist on buying homes, despite the highest multiple of home price to income among advanced economies and a housing-finance system that imposes high borrowing costs. South Korean women still drop out of the labor force when they marry or have children; only 38% of families have two wage earners (half the OECD average).

One of the most pernicious effects of the squeeze on middle-income households and the cost of the educational arms race is a voluntary one-child policy that has reduced the country’s fertility rate to 1.2 births per woman, among the lowest in the industrialized world. The population is aging at an accelerating rate, and the net flow of working-age citizens into the labor force has turned negative.

Without action, the economy faces the threat of declining consumption and even shrinking output. South Korea badly needs measures to relieve the stresses on middle-income finances and a new growth formula based on a globally competitive service sector and entrepreneurial small and medium-size (SME) businesses that create well-paying jobs.

Major reforms are necessary to help middle-income families escape crushing monthly payments for housing and education. Housing payments are higher because mortgages are of short duration (an average of ten years) and tight loan-to-value restrictions force borrowers to seek additional higher-cost loans from second-tier deposit institutions and non-financial companies.

These conditions need to change. Because banks would need to accept higher risk, a secondary market for mortgages is necessary. Policymakers should also consider measures to reduce demand for home ownership, including relaxing regulations on investment by insurance and other companies in residential housing, thereby creating better rental choices for middle-income households.

South Korea also needs to improve its public schools, particularly at the secondary level, and significantly upgrade vocational training. Families invest in private education because they fear that the public education system will not get their children into elite universities and good jobs. “Meister” high schools, introduced in 2010 specifically to prepare young people for high-skilled jobs, are a positive step.

Aggressive development of services – such as transport, retail, and restaurants, which today are dominated by low-productivity, low-paying local businesses, many run by sole proprietors – is another imperative. South Korea has excellent opportunities to build up health-care services and to compete in the global medical-tourism business. Other tourism, too, can expand to take fuller advantage of cultural and sports attractions. In financial services, the government should aim to produce 3-4 regional champions.

Finally, Koreans must relearn the entrepreneurialism that built the chaebol, the family-owned industrial conglomerates that powered the economy’s development. Today, South Korea has many small, family-owned businesses, but few entrepreneurs.

Fostering a more dynamic, innovative SME sector that will produce tomorrow’s globally competitive large companies requires removing disincentives to growth, such as the inheritance-tax exemption for family-owned businesses, which rewards owners for keeping their businesses small. A bankruptcy system that allows entrepreneurs to survive the inevitable failures that accompany innovation, as well as stronger protection of intellectual property and improved access to equity finance, are also needed.

Park takes over at a pivotal point in South Korea’s history. The new government needs to take the pragmatic steps that can overcome the limitations of today’s economic model and save the country from declining growth, higher unemployment, and rising inequality. The task is no less than to achieve South Korea’s second miracle on the Han River.

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    1. CommentedZsolt Hermann

      We will not find new "miracles" until we understand the root cause why previous miracles dry up.
      We keep talking about European problem, US problem, Chinese or Korean problems and so on.
      In truth what we see is the same dysfunctional template, model printed on different cultures, national or individual characteristics.
      It does not matter where we go, which country we examine, the system is the same everywhere: there exist a human pyramid, people layered based on the size and strength of their desire for self fulfillment.
      Those on top of the pyramid, are the ones with the greatest selfish desires, who are willing to go furthest for their own fulfillment, are driving the whole pyramid, and organize a system, most suitable for the actual culture, population, national characteristics, in order to keep themselves on top and suck as much as possible from the rest.
      It can come in the form of a Middle Eastern dictatorship, a communist one party system, or in the form of a "quasi free and democratic" parliamentary system for example, but the end result is the same, 1% brainwashing and exploiting the 99%.
      As globalization progressed the previously isolated, local, regional pyramids started to merge into international, multi-national pyramids but the basic system remained the same.
      Today this template reached the end of its use. The exploitation has reached such a level that the bottom part of the pyramid is falling off from underneath the top, thus even the peak of the pyramid starts feeling the strain, falling down.
      Today, despite some people still trying to force the pyramid system keeping the previous shape, or trying to reverse globalization, separating countries, regions from each other, this will be washed away by the new round, global, mutual nature of the new interconnected and interdependent human network.
      The pyramid system, or separation is against nature, since in nature all subsystems, all elements interconnect, and complement each other.
      We could go against the natural system so far, ignoring its laws and principles following our inherently selfish, exploitative nature, but we reached the limit of such behavior and now we are in a dead end.
      The true "miracle" has to come now, which is humanity honestly scrutinizing and understanding the problem, and as a result performing a "self-operation", an operating software change, instead of working for ourselves, working for the whole. This attitude change could transform the whole system, propelling it into previously unknown heights.
      Although this sounds ridiculous or impossible first, it only requires a minor psychological change, understanding: if we are all interconnected and our prosperity, well being, future depends on the whole network performing optimally, than it is in our best interest to work for maintaining the network, securing its optimal function.
      Those contributing the most, driving the system would still benefit from it the most, but in a natural, balanced and just way, not in today's distorted fashion.

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