Republic of Korea: Designing a new growth plan

Republic of Korea: Designing a new growth plan

17 April 2013

In half a century, the Republic of Korea has been propelled from one of the world’s poorest nations to the 12th largest economy in the world in terms of GDP.

However, it is becoming apparent that the export-oriented growth formula that brought prosperity to the country is running out of steam; a new growth plan may be required to restore the financial health of middle-income families, raise consumption and address societal and structural problems.

South Korea is the only county to have ever gone from being a recipient of OECD development aid to becoming a member of the donor committee. It is a market leader across several industries and its corporations have become globally recognised, with an increasing sphere of influence beyond the nation’s borders and the wider Asian region.

However, there are several symptoms emerging that suggest stress within its society. What’s more, the cause of that stress is largely economic, with more than half of middle-income households experiencing constraints on their cashflow. This highlights that the export-oriented growth model of the past has served its time, and a replacement that raises the spending power of the middle class and encourages innovation is crucial in order to guarantee the longevity of the country’s prosperity.

A new report by McKinsey, entitled Beyond Korean Style, outlines a few ways in which this may be achieved.

Encouraging growth in the SME sector

Small and medium-sized enterprises (SMEs) act as the underbelly of the economy, and fostering growth within this sector is essential for long-term growth. In South Korea, however, the SME sector is largely fragmented, with most firms leaning towards the small end rather than mid-size and growing companies.

As a result, many of these companies are not providing high-paying jobs, creating a funding gap in the economy. The service sector is also largely absent from the economy, which has left it rather exposed to shocks in the manufacturing arena. Apart from a few standout service industries, the sector remains concentrated in low value-added areas, and productivity is   30-57% lower (as a value added per employee) compared to the US or the UK.

Moving forward, it is essential that the service sector is expanded and strengthened. The McKinsey report notes that “a central goal of national economic policy should be to improve the capabilities of the service sector, raise productivity, and create high value jobs”. The same goes for the SME sector, and policymakers must clear the path to entrepreneurship and provide assistance to help growing businesses scale up.

Middle class incomes

Many problems in South Korea are caused - or emanate from - the rising financial stresses on middle-income households. The middle-income cohort has fallen from 75.4% of the population to 67.5%, and a rising share of those who remain are cashflow-constrained. With house prices increasing and financing costs also on the up, a generation of squeezed middle classes has emerged.

The McKinsey report suggests two approaches for reducing the cost of borrowing which could release much-needed cash. The first is to move to the longer-term, fixed-rate mortgages that are common in other developed economies. Secondly, a reduction in the share of high-cost lending from second-tier banks and non-financial companies could help reduce housing payments.

To reduce the spend on private education there should be a re-evaluation of how higher education is run in the country. Investing in a dual-track system for secondary and post-secondary education could also reduce education spend, and free up household income.

Labour market challenges

The final set of challenges comes in the form of participation in the labour market and family formation. While the unemployment rate is healthy, the McKinsey report finds that this figure actually obscures a more complex reality. For example, there are 900,000 college students who have left school temporarily to seek work to support their education, and several categories of uncounted unemployed, such as discouraged workers who have ceased to seek employment.

There are also fewer dual-income households than in other advanced economies, and most women withdraw from the labour force when they marry or have their first child. Plunging fertility rates are also a major concern, with birth rates falling by more than most other advanced economies.

The government must recognise the need to make it easier for mothers to choose to work outside the home and rise childcare subsidies by more than 20% a year, the McKinsey report advises. A series of initiatives that will enable women to work up to their capabilities, even after the birth of a child, will lead to more flexible work schedules and a better work/life balance for all families.

TMF Group

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