Newsweek Japan asked me for an long-form essay on Korea’s economy for its December 5 issue (cover story to the left). Here is the link in Japanese, but I thought it would be useful to publish the original, untranslated version as well. (If you actually want the Japanese language version, email me for it please.)
The essay broadly argues that Korea needs to move beyond ‘developmentalism’ toward economic liberalism, as a lot of Asia does in my opinion. Regular readers will see themes I have emphasized before. This was intended for the print edition, so there are no hyperlinks included in the text. Here we go:
“As Korea’s presidential election moves into the home stretch (December 19), the local economic discussion is sharpening. Inequality, demographic collapse, massive concentration of economic weight in a few mega-conglomerates, weak consumer purchasing power, growing trade friction over intellectual property rights, and a chronically under-powered small- and medium-enterprise sector (SME) are among the major problems this outwardly very successful economy must confront. Unfortunately, none of the major candidates are pushing the deep reform needed to fix these underlying issues. As with China’s leadership transition, things seem so good at the moment that elites are wary of rocking the boat; as with the recent American election, tough choices will likely once again be kicked down the road. In Korea’s case, that means moving away from its ‘developmentalist’ growth model before encountering troubles similar to Japan’s.
Korea’s elites may be forgiven for taking victory lap. Barack Obama regularly invokes Korea as a model for science and math achievement, or manufacturing prowess. Korea’s GDP continues to expand 3-4% per annum, while many OECD states have struggled to maintain stable growth in the last five years. The Great Recession did not bring about a cataclysmic bank crash, real estate implosion, massive contraction of exports, or other colossal shock. Korea’s national debt is only 35% of GDP, and its budget is in balance. Overt poverty is rare. A just-right safety net is thick enough to avoid the severe income polarization of the US, but thin enough to avoid European-style dependence. Its exports continue to expand; Korea has run a trade surplus every year since the Asian financial crisis. Korean cars, ships, TVs, and other electronics are now world-class, giving long-standing rivals like Sony or General Motors a run for their money. Koreans speak with justifiable pride of the ‘miracle on the Han.’
But this self-congratulatory narrative covers significant problems that can be captured in Korea’s trouble transitioning from ‘developmentalism’ to economic liberalism. ‘Developmentalism’ is a term developed in the study of international political economy to identify the unique ‘Asian model’ economy that emerged after WWII. Japan laid the initial framework, but others like Korea, Singapore, Taiwan, and now of course, China have followed. In this model, the state intervenes heavily in the market, guiding or directing both producers and consumers with industrial policies like ‘five year plans.’ The state channels investment into chosen sectors, frequently facilitating the emergence of mega-conglomerates with deep (and often corrupt) ties to the state. Korea’s chaebol are effectively copies of Japan’s earlier kereitsu. The purpose was to export the state into modernity, and exports were kept cheap with tweaked exchange rates, repressed wages, and copious ‘soft credit’ from para-statal banks for ‘national champion’ firms.
So successful in generating ‘miracle growth’ (5-10% a year) was this model in Japan that it spread rapidly around Asia and garnered heavy attention from scholars and international financial institutions. Unfortunately, it has significant downsides once an economy reaches OECD maturity. For example, as Japan and China have learned, it is hard to start the engine of consumer spending when consumers have been told for decades that high saving is national duty. Southeast Asia learned that it is extremely vulnerable to foreign banking and swings in demand, because export-promotion so heavily ties it to foreign sentiment. In Korea’s case, the limits of its development model are showing up in three main areas:
One obvious outcome of Korea’s dirigiste economic model is the enrichment of elite families connected to the mega-conglomerate chaebol. (Indeed, familial economic elitism is an outcome of the Asian model almost everywhere – China, Indonesia, and Singapore as well.) These families are Korea’s own latter-day aristocrats, the subject of simultaneous envy and resentment. Korean soap-operas salivate over their life-style of gated-communities, spacious homes (not apartments), elite schools, and import sports cars most Koreans never enjoy.
Until the Great Recession, inequality (measured formally by the ‘Gini coefficient’) had been rising sharply. The popular feeling that Korea is dominated by wealthy of clique of interlocking political and economic elites has broken out in a protracted discussion over free school lunches, capping university fees, and widespread unregistered ‘grey market’ employment (‘labor market dualism’). All of the presidential candidates are promising to take a harder line on the chaebol to improve the ‘economic democratization’ of Korea, although similar promises from past candidates have evaporated post-election.
More importantly, Korean consumers suffer from persistently weak purchasing power, resulting in skyrocketing domestic debt. At a staggering 155% of income, Korea’s consumer debt is the highest in the world. The Bank of Korea (BoK), the central bank, regularly intervenes to ‘sterilize’ the won’s appreciation by printing more won and buying up dollars. While this keeps Korea’s exports cheap, it feeds inflation (now over 4%), which in turn reduces the purchasing power of the won. In short, the BoK rewards Korea’s politically-connected mega-exporters with an artificially low exchange rate, while punishing Korean consumers with an artificially depressed currency. The result is heavy borrowing and a flood of ‘quick cash’ loan shops advertising on television.
As I note in the companion piece on the Apple-Samsung battle, the extraordinary concentration of economic weight in Korea is very damaging. The ‘commanding heights’ of Korea’s economy are dominated by 63 large business groups, the chaebol. The very largest of these oligopolists – Samsung is the best known – absolutely overawe everything else in Korean life including the government itself. (An oligopoly is the concentration of a market sector in the hands of few dominant firms; a monopoly is the same with just one massive player. The most famous recent monopoly is probably Microsoft’s Windows in the computer operating systems market.)
Worse, the biggest chaebol are often not only oligopolists within just one sector but are multi-sectoral octopuses, leveraging their market dominance in one area in order to penetrate others. For example, SK company is a huge market player in cellphones, gas stations, and real estate. There is no reasonable market explanation how these wildly diverse sectors could synergize into one coherent firm. Instead, the explanation is obviously political – the Korean government was unwilling to restrain SK from cross-leveraging its market power to push into unrelated sectors.
Again, this is a well-known problem in ‘Asian model’ states. The urge to create mega-exporters that could compete in scale with large western firms meant the Korean government overlooked, or indeed facilitated, the emergence of enormous monopolists and oligopolists. But monopolization/oligopolization has well-known side-effects that frequently outweigh any benefits of scale and which are very apparent in Korea.
Among others, massive market players develop close, cronyistic relations with the state, especially regulators (collusion), in order to politically screen out competition. Two years ago, Korea’s cellphone companies shamelessly exploited a ‘phone security’ gimmick that only existed in Korea to buy time to defend themselves against the iPhone. And it is widely suspected that the government colluded with the local telco industry to prevent Apple from entering and taking market share while Korean firms were still producing dull flip-phones. As a result, Koreans pay too much for cellphones and service plans, and could only buy smartphones much later than in comparable countries.
Similarly, the mega-firms use their relationship with the state to push for the currency depreciation discussed above and other ‘rent-seeking’ benefits such as tax breaks, regulatory laxity, and direct subsidization if necessary. This hurts Korean consumers, taxpayers, and SMEs, but their diffuse public interest is lost before the concentrated financial and political power of the chaebol who dominate the national imagination. Indeed, perhaps the most discomforting element I see as an expatriate teacher in Korea is the average Korean’s identification of Korea’s national interest with these firms: ‘what’s good for Samsung is good for Korea.’ Of course this is not true, as Samsung is simply a firm. Unfortunately, the emotional hold of Samsung, LG, SK, and others, gives these national champions enormous leverage to extract benefits from taxpayers – most obviously the government bailout in the 1997 crisis – that damage the average household budget. Yet the dream job of most of my students is to work for Samsung, and even among my academic colleagues, I find that most do not support a free currency float of the won, because it would reduce the profits of these revered national champions.
A last well-known, dysfunctional outcome of the state-led, high-export growth model is its punishing effect on families. In the sprint for national development, frequently promoted by the government like an ideological crusade, private life shrinks. Productivity increases by ‘encouraging’ long work hours, and the Asian model has frequently emphasized working on weekends and intensive, expensive schooling.
Not surprisingly, this has powerful negative impacts on families. The huge emphasis on work and success leads to delays in marriage. The average Korean now marries at age 30. Children turn from a labor boon in rural environments, to a brutally expensive financial burden on the urban family. Koreans spend around $15 billion a year on private education (hagwons), and around 75% of pre-college students attend these cram schools. Given the expense, Korea, like Japan, now has one of lowest fertility rates in the world (1.2 live births per female, which is lower even than North Korea). Finally, these pressures have pushed up divorce and suicide rates. Divorce as percent of marriages has tripled in Korea in the last three decades, and its suicide rate is now the highest in the OECD.
The outcome of these disturbing trends is a rapidly aging society. Koreans over 65 were roughly 5% of the population in 2000. Today they are 10%, and by 2050, they are predicted to be staggering 40%. This is even faster than Japan’s accelerated aging, and, also like Japan, Korea will enter absolute demographic decline in the next two decades. (China’s one-child policy is having a similar effect, and birth and marriage rates around Asia generally are tumbling.)
The effects of these shifts are well-known. Fewer working-age people will eventually slow GDP growth, as less labor enters the system. This will raise pressure for immigration to keep growth high to pay for retirees. But immigration in turn broaches explosive issues of social identity and multiculturalism, traditionally very challenging in communitarian Confucian Asia. An expanding pensioner class will also place greater pressure on working-age Koreans to transfer resources between generations, creating potentially volatile ‘inter-temporal’ political divisions. Medical resources will skew to the concerns of the aged who will vote their interests. Smaller families will have trouble caring for parents, creating pressure for senior homes and other ‘grey infrastructure.’ Korean national security may even be jeopardized as the army shrinks relentlessly, while North Korea continues to field a massive force.
What to do?
The issues raised here are well-known and regularly discussed in the Korean media. Others could be added – too much Korean schooling focuses on rote memorization; SMEs are chronically prey to the chaebol, badly inhibiting creativity and upstart challengers against established winners with little interest in change; Korea’s political parties and parliament are disturbingly immature for an economy this wealthy. And of course, looming over all this is North Korea. One day it will collapse, with the potential to throw Southern society into chaos.
But there are some fairly obvious steps that Korea can take to accelerate its move away from developmental dirigisme toward a more open, liberal economy. Japan has taken some of these steps itself. Here are two:
Enforce antitrust provisions to break the chaebol chokehold on Korean economics and politics.
Korea’s corporate governance norms are appalling by OECD standards. Shareholder rights are minimal. The mixed, family cross-holding relationships that control Korea’s largest firms are murky tangle that no one really understands. The government tolerates all this because of their massive influence on the political class and public opinion. The legal framework exists to prevent gross over-concentration; it is simply never used. The only reason these firms are ‘too big to fail’ is because the government is too cowed to break them up. By contrast, in the West, many of these firms would have been broken up in the public interest long ago.
Smaller mega-firms would bring countless liberalizing-modernizing benefits: Industry would have less money to throw at Korean politics, reducing the endemic corruption of Korea’s political class. Korea’s dirty politics are an embarrassment. Smaller behemoths would not be able to block or buy out interesting challengers arising from the SME sector. Markets would be more vibrant and less staid. Nor would shrunken mega-exporters be able to bully the BoK into sterilizing exchange rate appreciation. This would noticeably improve the average Korean’s balance sheet, slow inflation, and improve relations with states like the US and Japan who believe Korea cheats at trade.
Embrace Family-Friendly Work Environments and a Normal Work Week
An unfortunate vestige of Korean patriarchal Confucianism is the continued imbalance of work-family pressure on women. Much of the discussion about immigration, with the attendant social disruption it might entail, could be defused if women could better balance career and motherhood. In fact, the same would and should apply to men. But Korea provides little quality daycare or at-work childcare. Hence women, frequently the child care-provider, are often forced to leave the workforce if they want to have children. But with a modern, educated female population eager for professional success, many choose to avoid family and children or delay that until their thirties. A simple policy solution would be safe at-work daycare. If mothers (and fathers) know that the physical separation from their children on-site will be minimal and safe, that dramatically rebalances the equation in favor of further children.
Similarly, outrageously expensive hagwons, schooling children till 11 pm on Saturdays, and 60-hour work weeks for husbands is a recipe for family collapse, social chaos, and, eventually, economic slow-down. Such extra-hours supposedly improve GDP, but it is not hard to imagine that all the psychological stress this creates may well inhibit productivity more than improve it. The costs in divorce, depression, and suicide are already apparent. The government could take far tougher action were there political will.”
Cross-posted on Asian Security Blog.