North Korea is grabbing global headlines by threatening aggression against its neighbor to the south and the United States. And once again, South Koreans are largely shrugging off the rhetoric from the north. This nonchalance gives South Koreans the chance to focus on another existential threat - one that's not so easily dismissed as bluster. South Korea's economic success, write Richard Dobbs and Dongrok Suh in Foreign Policy.
Once again, North Korea is grabbing global headlines by threatening aggression against its neighbor to the south and the United States. And once again, South Koreans are largely shrugging off the rhetoric from the north.
This nonchalance gives South Koreans the chance to focus on another existential threat -- one that's not so easily dismissed as bluster. South Korea's economic success -- the growth formula that brought forth the "miracle on the Han," set records for development, and is a model for other emerging economies -- is no longer working for a great many Koreans. The nation is beset by a deep middle-class malaise that could limit the consumer spending needed to create a more balanced economy and might eventually limit gross domestic product growth itself.
Yes, the government-backed programs to build up export-oriented manufacturing still produce results: South Korea leads in memory chips, LCD displays, and mobile phones; its multinationals such as Samsung, LG, and Hyundai are taking a larger share of global markets. But the typical middle-income Korean is increasingly left behind. As giant manufacturing concerns expand overseas, they are cutting employment at home, leaving job creation to the nation's small and medium-sized enterprises (SMEs) and service industries. In contrast to South Korean manufacturing firms, most of these companies are far from world-class competitors. They have much lower productivity and offer substantially lower pay.
In South Korea, over half of middle-income citizens (households making 50 percent to 150 percent of the median wage of $37,000) are paying out more each month than they bring in. South Korea's household saving rate has plunged from one of the world's highest (19 percent) to one of the lowest in advanced economies (4 percent). It has the highest suicide rate among nations in the Organisation for Economic Co-operation and Development (OECD) and one of the world's lowest fertility rates. Today, South Korea faces a war on two fronts: the prospect of a shrinking labor force along with a rapidly aging population.
Complicating matters, middle-income South Koreans are reluctant to adapt to the new reality. Women continue to drop out of the labor force to raise children (only 44 percent of Korean families have two wage earners, compared with 57 percent across the OECD), while families continue to pay a disproportionate share of income for two obsessive priorities: home ownership and education.
A new South Korean growth formula is necessary to chart the continued trajectory toward a successful and prosperous future. To relieve the strain on middle-income households caused by perverse spending priorities and create new well-paying jobs by bolstering the service economy and SMEs, the government must first attack housing costs. House payments are particularly burdensome in South Korea because most mortgages are of short duration (10 years or less) and loan-to-value (LTV) limits are tight (most mortgages are for about 50 percent of home value). While these LTV limits have protected the banking sector, they force borrowers to take out additional high-interest loans to make their home purchases. Simply by raising LTV limits and rolling those loans into larger mortgages, South Koreans could save $8 billion a year, according to our analysis. The government has already set a goal for increasing high-LTV loans, but more can be done. Other tactics would include encouraging a more robust rental market by allowing more investors (such as insurance companies) into that sector and encouraging competition that would raise the quality of rental housing.
Getting South Koreans to stand down from their education arms race will not be easy. Despite growing evidence to the contrary -- unemployment is higher for college graduates than for vocational-school grads, for example -- Koreans cling to the belief that the university degree is the only ticket to success. South Korea needs to invest more in vocational education; it should expand its new Meister high school system, a transplanted German idea to invest in schools that provide job-specific training and a path to employment. Eventually, parents will see that there is a choice.
South Korea can also do more to build up services and SMEs. In addition to building on the success of sectors such as construction engineering that are already globally competitive, South Korea can expand sectors such as health care, tourism, and financial services. In health care, South Korea has both opportunity and need. It spends just 6.9 percent of GDP on health-care services, compared with 9.6 percent in the average OECD nation, but it has a rapidly aging population that will raise demand. In particular, South Korea can expand primary care to treat patients with chronic conditions, including the elderly.
Finally, to build up SMEs, South Korea must reduce barriers to growth and try to establish a culture of entrepreneurism. It is ironic in a country dominated by chaebol (the mega-corporations created by master entrepreneurs) that most business owners are risk-averse -- focused only on making a living. But there are structural barriers, too: the chaebol rely heavily on captive suppliers for business services such as IT support, a practice that stifles competition, despite laws aimed at helping small businesses. Other regulations continue to discourage growth: estate-tax rules allow owners to pass on their businesses tax-free, as long as they are below a certain size.
South Korea needs to celebrate and teach entrepreneurism; that means better access to capital, stronger intellectual-property protections, and bankruptcy laws that let entrepreneurs recover from failures. Seoul should recognize that efforts to address these barriers have not gone far enough and should consider a more comprehensive and consistent approach to helping small companies innovate and strive for growth. A new wave of innovation can help build another South Korean miracle -- one that might have China and other rapidly developing economies looking to Seoul for inspiration as they tackle similar challenges in the coming years.
This article originally ran in Foreign Policy.