ed Korean economy faces 'boiling frog's dilemma'
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By Lee Chang-sup
Korea’s economic downturn is likely to continue over the long term, and structural problems are to blame.
The Bank of Korea reported the country grew by less than 1 percent for the seventh consecutive quarter. Asian Development Bank forecast that Korea would have the second-lowest growth rate this year among the 11 major Asian countries. It initially predicted Korea’s 2013 growth rate to be 3.4 percent, but later revised the figure to 2.8 percent. Either way, these figures are far below the Asian average growth rate of 6.6 percent. Hyundai Research Institute (HRI) also concluded that the economy has nearly stopped growing.
This gloomy outlook is but a continuation of the country’s economic downturn in the last 10 years. From the late 1970s till the late 1990s, Korea had one of the highest growth rates in Asia. However, Korea’s growth rate began to fall dramatically from 7-8 percent in the 1980s to 5-6 percent in the 1990s and further to 2-3 percent in the 2000s.
Structural rather than cyclical problems are to blame for this downturn in the export-driven country. One of these structural problems is deflation, which is no more apparent than in the real estate market. Apartment prices have fallen by 30-40 percent over the past five years. The depressed property market has reduced consumer spending and slowed economic growth, which in turn cut household income. Economists like Harry S. Dent, Jr., author of “The Great Crash Ahead,” predicted that like many other countries, Korea would continue to face this deflationary trend, at least for the next decade.
The country’s low fertility rate is another structural problem significantly affecting the economy. Korea’s fertility rate has fallen by two-thirds since the 1970s. The country currently holds the fourth-lowest fertility rate in the Organisation for Economic Co-operation and Development (OECD). Should this trend continue, the labor market will contract and dampen the country’s growth potential.
Conglomerates such as Samsung, Hyundai, LG and SK have become world leaders in their respective industries. However, their success did not trickle down to the rest of the Korean economy. According to McKinsey Global Institute (MGI), conglomerates’ share of domestic employment fell from 18 percent in 2000 to 12 percent last year.
In contrast, smaller businesses are not faring well. The Korea Federation of Small and Medium Business reported factories of its member companies ran at only a 69.8 percent capacity in February, a 42-month low. Further, companies refrain from investing and instead hoard their cash, which is the most valued asset during a deflation. According to Statistics Korea, businesses’ investment in production equipment has contracted for the 10th consecutive month in March.
South Korean citizens have also been suffering from the country’s snail-paced growth. For the past 15 years, household income has grown at half the rate of more than 9 percent in conglomerates’ productivity, and nearly 55 percent of middle-income families have a deficit, according to MGI.
In addition, South Korea’s household savings rate has fallen from among the world’s highest to the lowest, according to the OECD. Despite the low income and savings, however, middle-income families continue to overspend in housing and education, which also depresses consumption, family size and birth rate.
South Korea’s problematic politics is another structural problem that drags down the economy. Among the 34 OECD countries, Korea ranks 31st for accountability, 29th for political stability, 27th for control of corruption and regulatory equality, 26th for rule of law and 20th for government effectiveness.
Many economists believe Korea is at the early stage of the structural economic downturn Japan has been experiencing in the past two decades, during which its asset price collapsed, depressing consumption, household income, stock and bond prices and exports.
Korea’s economic woes are aggravated by the weak yen. In mid-November, Japan implemented a low-yen policy through monetary and fiscal expansion. The Japanese yen has weakened 23 percent against the dollar since then, benefitting Japan but disadvantaging Korea. Japan’s stock index has risen 28 percent this year, while Korea’s has fallen by 4.5 percent.
Further, the strong Korean won has made Korean exports relatively more expensive. According to HRI, this scenario mimics the currency crisis in Korea in the late 1990s, during which a weaker yen reduced Korea’s exports and increased its imports, putting the country’s current accounts in a deficit and triggering a dollar shortage.
There are no quick fixes that will kick-start the economy. Some liken Korea’s situation to the “boiling frog’s dilemma”: a frog will jump out when it is placed in boiling water; however, when the frog is placed in cold water that is then slowly heated, it will not perceive the danger and thus, will be slowly cooked to death. South Korean policymakers need to realize significant changes can occur gradually, and the government needs to act now before it’s too late.
The government should begin reviving the economy by expanding money supply, providing a fiscal stimulus, cutting the interest rate, weakening the local currency, slashing taxes and strengthening deregulations. The government should provide incentives for companies, Korean and foreign, to relocate their factories to Korea. Many economists say Korea needs bold steps to hike the nation’s growth potential from the current 3-4 percent to 5 percent. The stimulus package should be massive enough to match Japan’s recent ones.
Lee Chang-sup is the executive managing director of The Korea Times. Contact him at editorial@koreatimes.co.kr.