The perils of cheap labor

By John Burton

One of the bright spots in the beleaguered administration of Park Geun-hye has been the appointment last summer of Choi Kyung-hwan as finance minister. Choi has generally won plaudits from local and international investors for his pragmatic policy in reviving economic growth.

His most popular measure among investors has been to increase taxes on retained earnings held by the big business groups so that they spend more in the domestic market and reduce their heavy dependence on exports. An added benefit of the policy is meant to encourage local spending by the chaebol to help the growth of smaller companies, which are also receiving tax incentives to hire more people.

The clearest result of this policy has been the decision by companies like Samsung Electronics and Hyundai Motor to increase their dividend payments, which have been notoriously meager, in response to the threat of new taxes.

Local and foreign investors believe the measures could lead to a re-rating of the Seoul stock market that has long suffered from the "Korea discount," which refers to the fact that shares of Korean companies have low valuations because of miserly dividends and a lack of corporate transparency.

Although praised, most of Choi's measures, however, are still seen as having only a short-term impact when Korea needs to undertake more extensive economic reforms to guarantee its future prosperity.

The country faces a number of daunting challenges from increased social spending to support a rapidly aging population to household debt levels that are among the highest in the world. If these problems are not solved, Korea could face a prolonged slump like Japan because domestic demand would be strangled as consumers are forced to cut back spending due to accumulating debts while increasing savings for retirement.

The issue of boosting domestic demand and promoting business investment is taking on increased importance as Korean exports start to falter because of economic weakness in Europe and China.

The most effective way to increase domestic demand would be to encourage companies to raise wages, which was one of the goals the tax on excess retained earnings hoped to achieve. Choi has proposed raising the minimum wage, which is quite low by OECD standards, as a first step to boosting wages overall. Corporate executives have not played along, however. When Choi recently discussed the idea of higher wages when he met with the heads of the five leading business lobby organizations, he got an earful.

The corporate chieftains said that increased pay would only raise production costs, resulting in Korean companies losing price competitiveness in international markets. If export sales fell, then Korean companies would have to cut employment, which would hurt domestic demand, they argued.

Korean companies increasingly prefer hiring workers on a short-term contract basis rather than offering full-time employment because it saves money on wages and benefits. But workers with lower incomes also mean less spending power at home.

It is noteworthy that the main response by some companies to the new excess earnings tax has been to splurge on what has been criticized as vanity projects instead. Hyundai Motor's controversial move last year to pay an inflated price of $10 billion to acquire land from KEPCO to build its new headquarters in southern Seoul was seen as a response to the new tax policy, but angered outside shareholders.

The best way to solve the dilemma posed by higher wages is to increase productivity, which would allow companies to accept increased salaries without losing competitiveness. Proposed government policies such as deregulation and solving labor market rigidity could go some way to increasing productivity as well.

But a key reason for Korea's faltering productivity rate can be blamed on the chaebol and their inefficient management practices. There is nothing wrong per se with large business groups when it comes to promoting growth and productivity. Bigger firms with their economies of scale tend to be more productive than smaller ones.

But the top-down bureaucratic management of Korean companies is increasingly stifling worker productivity when the country is relying less on manufacturing and more on service industries, where productivity is particularly bad.

Paying workers cheaply does not contribute to greater efficiency because low wages provide little incentive to work harder and smarter. Korea has so far resorted to interest rate cuts to keep up domestic demand, but what happens when the government is forced to ease back on such stimulus measures, which it must do sooner or later? Increased productivity would then have to fill the gap.

But Korea's top executives ignore such arguments when corporate profits for many of them are rising despite slowing economic growth. The best way to achieve productivity is for companies to spend more on training a skilled workforce, while the government should foster increased domestic competition so that productive employees can be suitably rewarded. Cheap labor is no panacea.

John Burton, a former Korea correspondent for the Financial Times, is now a Seoul-based independent journalist and media consultant. He can be reached at john. burton@insightcomms.com.

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