ed Korea needs to escape middle-income trap

By Lee Chang-sup

Korea remains stuck in what economists call the middle-income trap. Domestic consumption and investment are nearly frozen. Small-scale exporters find themselves behind their rivals in advanced countries in terms of higher-value products. Manufacturing is likewise stagnant while the service sector remains underdeveloped.

According to Hyundai Research Institute (HRI), Korea’s growth potential has nearly halved from 6.5 percent to 3.7 percent in two decades. Per capita income has stagnated in the $20,000 range for the past five years.

For the first time in 15 years, Japan will outgrow Korea this year — 2.9 percent while Korea only by 2.6 percent. This is a surprise because Japan’s economy is six times as large as Korea’s.

Korea’s stagnant growth has two main roots — anemic domestic consumption and investments. The economy has become too reliant on exports. Consumers, burdened with mortgage debts and private tutoring bills, have reduced spending. Meanwhile, companies are reluctant to invest because of unpredictable returns, according to HRI economist Kim Dong-ryul.

However, there are many other factors of the country’s slow growth. Kim and other economists say the age demographic is another crucial factor. They predict Korea will not see a dramatic upturn in growth in the future because of the aging population. As the population ages, the pool of workers declines, fiscal burden increases and growth slows down. Korea’s aging index — the number of people 60 years old and over per 100 people aged 15 and below — is expected to exceed 80 percent for the first time this year, according to Statistics Korea. The agency also predicted that seniors will reach a record high of 12 percent of the population.

The low birth rate is also a factor that drags the economy down. In 2012, the nation’s birth rate was 1.3, the lowest in the Organisation for Economic Co-operation and Development (OECD) and lower than the global average of 1.7. The birth rate has risen for the past three years but only marginally. According to Harry S. Dent, Jr., author of “The Great Crash Ahead: Strategies for a World Turned Upside Down,” Korea needs to boost its birth rate to 2.1 to avoid the looming deflation, which he says may persist for the next decade.

Corporate and governmental transparency is also critical in boosting growth. HRI said Korea’s transparency index is 5.5, well below the average of 8 for industrialized countries with a per capita income of $40,000. Transparency International, a global coalition against corruption, believes Korea has a long way to go in eliminating corruption from its society.

Only nine countries with a population of more than 10 million have successfully overcome the middle-income trap and realized a per capita income of $40,000: the United States, Japan, Australia, the Netherlands, Belgium, France, Canada, Germany and Sweden.

These countries have seven traits in common, according to HRI. First, it took them 9.6 years to increase their per capita income from $20,000 to $30,000. Korea may take up to 12 years to achieve this goal. These countries spent another 5.6 years to reach the $40,000 threshold. To escape the middle-income trap, they also hiked their growth potential, employment rate, birth rate and transparency. They fostered a competitive service sector and kept national debt below 60 percent of the gross domestic product and trade surplus.

Italy, Spain and Greece are other countries that remain stuck in the middle-income trap. Their growth rate fell after they realized the $30,000 per capita income threshold because of many factors, including a weak manufacturing base; bad fiscal health; higher imports than exports; and a birth rate and transparency index below the OECD average.

Korea is poised to either overcome the middle-income trap or remain stuck there. It could become successful like the U.S. and Germany or unsuccessful like Greece, Spain and Italy.

HRI reported Korea has achieved two out of the seven conditions necessary to escape the trap: fiscal soundness and trade surplus. The country needs to fulfill the five other conditions. It needs to improve its service-sector productivity, which is less than half of manufacturing productivity, according to the OECD. It also needs to raise the birth rate to at least 1.8. The country should also increase transparency in doing business. Finally, it needs to increase the current employment-to-population ratio — the proportion of the working-age population that is employed — from 64 percent to greater than 70 percent. Hiking growth potential is also necessary.

In her inauguration speech in February, President Park Geun-hye said she would create the “Second Economic Miracle on the Han River.” She appealed to the people to become partners for this miracle. However, three months into her presidency, she has yet to unveil a strategy for realizing this vision. She needs to remember that a slogan does not create a miracle.

Indeed, Korea needs to begin charting strategic plans to expand its growth potential. Cash-rich conglomerates should immediately expand investment. The government should actively campaign to attract foreign investments and sign as many free trade agreements as possible, for example, with China and Japan. It should also deregulate the service sector to encourage foreign investment, hike employment and increase consumer spending.

Lee Chang-sup is the executive managing director of The Korea Times. Contact him at editorial@koreatimes.co.kr.