WASHINGTON, Dec. 30 (UPI) -- South Korea has been a shining economic example for four decades, with an extraordinarily rapid and sustained growth rate, even after the 1997 Asian crisis. Now, with the election of Millennium Democrat Party president Roh Moo-hyun, this may be about to change. The Japanese disease beckons.
Roh's economic plan was outlined in some detail Dec. 24 by United Press International's Jong-heon Lee. It differs significantly from the economic path South Korea has followed in the past, either under the Grand National Party presidents who ruled until the end of 1997, and produced the world's fastest economic growth -- 8 percent per annum for 35 years -- or under the MDP's current president Kim Dae-jung.
Roh, in a major policy address following his election, announced that he seeks a new path for the economy based on the redistribution of wealth, citing a Bank of Korea report that the top 5 percent of Koreans control some 40 percent of the country's financial assets. Roh will also carry out deep surgery on South Korea's chaebol business conglomerates, and downsize them, while he was unenthusiastic on the privatization of government-owned banks, electric utilities and the railway network.
Roh called for reorienting the country's taxation system so as to impose more taxes on the rich, especially wealthy business and property owners, while reducing the tax burden on lower income households -- raising inheritance and gift taxes, for example, in order to discourage inherited wealth. He vowed to raise the social welfare budget of the government from 10 percent to 13.5 percent of gross domestic product. In another spending plan, Roh pledged to move the capital out of Seoul despite the huge cost of such a move, "to make the stabilization of citizens in all aspects a priority."
On the labor side, Roh will move to a five-day workweek "as soon as possible," expanding subsidies to small- and medium-sized companies that employ the five-day workweek.
On top of all this, Roh pledged to increase the country's economic growth rate from the 5 percent to 5.5 percent expected in 2002 to around 7 percent over the next 10 years.
If you think you've seen these policies before, you have. These -- higher taxes, subsidies to small business, attacks on big business, social engineering, huge public spending and wealth redistribution -- are the policies of India's first post-independence Prime Minister Jawaharlal Nehru, and the Congress Party governments from 1947 to about 1990. Notoriously, they produced nothing like a 7 percent per annum economic growth rate. There is little reason to suppose they will do any better in South Korea.
Start with income distribution. I covered this subject in some detail in my column on Latin America three weeks ago. If South Korea was a Latin American country, with a very high GINI coefficient (a measure of inequality) -- between 0.50 and 0.60, compared with the current U.S. GINI of around 0.40 -- then a certain amount of income redistribution would make sense. One would not of course trust the government to do it (particularly not a Latin American government.) Instead, a program of increased private sector investment in education and infrastructure, an opening of the economy toward international trade and tourism (both of which increase service job opportunities towards the bottom of the scale, rather than unionized industrial labor, generally entrenched near the top of the scale) and an expansion of domestic small business, particularly in the service sector, would all make sense.
However, South Korea is internationally at the opposite end of the GINI scale from Latin America. Its GINI, towards the upper end of the apparently optimal range of 0.30-0.40 in the late 1970s, has steadily reduced since then, and according to the latest statistics, those for 2000, it is now around 0.32. Not only is this not dangerously high, it is in fact on the low side, below Japan (0.35), Singapore (0.39), Australia (0.35) Britain (0.36) and France (0.33), and only just above Germany (0.30). Only the legendarily egalitarian Scandinavian countries, such as Sweden (0.25) are lower. Whatever South Korea's economic problems are, inequality is not one of them. Heavy-handed government attempts to reduce inequality thus carry a severe danger of killing the goose that lays the golden eggs of wealth creation.
Roh's intention to increase government spending is also disturbing. If social expenditure is to be increased by 3.5 percent of GDP, and additional huge expenditure is to be incurred on moving the capital away from Seoul, it is likely that South Korea's government spending will increase by at least 5 percent of GDP, from 25 percent to 30 percent. While not an alarming level by international standards (U.S. government spending today is about 32 percent of GDP) the increase comes on top of an increase from 20 percent of GDP to 25 percent since 1996, the more or less inevitable result of the 1997 Asian crisis. Thus South Korea's spending to GDP ratio will have increased by 10 percent of GDP, from 20 percent to 30 percent, in around a decade.
This has severe implications for economic growth. As I demonstrated in a previous column in 2001, using statistics from the Organization for Economic Cooperation and Development dating back in many cases to 1960, economic growth is negatively correlated both with the level of government spending (as a percentage of GDP) and with its rate of increase, with each of those two factors accounting for around a quarter of the variation in growth rates. This is intuitively plausible; to the extent that government soaks up more of the resources available, particularly of the new resources available in a given year, it reduces the resources that remain for the more productive private sector.
While South Korea's overall level of government spending will not be excessive, assuming that Roh does not engage in "pump priming" beyond the commitments he has already made, the spending increase of 10 percent in a decade is comparable to the large public spending increases in countries whose growth unexpectedly slowed, such as Japan (21 percent, from 25 percent to 46 percent of GDP, spread over the 30 years 1971-2001), Germany (10 percent, from 37 percent to 47 percent, in 1970-75, which killed off the economic miracle) and Spain (25 percent, from 22 percent of GDP to 47 percent, over the 19 years 1974-93, a period of stagnation following fast growth in 1950-73). Only Finland, increasing public spending from 41 percent of GDP in 1989 to 59 percent in 1993, thereby putting itself into catastrophic recession (GDP dropped 7 percent in 1991) grew government significantly more aggressively.
One caveat. If Roh were to increase public spending without increasing taxation it would, in the short term, have a stimulative effect -- John Maynard Keynes was correct here, just as even a blind pig finds a truffle sometimes. South Korea's debt to GDP ratio is only 26 percent, and the country runs a trade surplus, with a currency that is somewhat undervalued, so a large public sector deficit could easily be financed, at least for a few years.
However, Roh hasn't said he'll do this. If he pursues orthodox leftist policies, and finances a big increase in public spending by increased taxes on the rich, then South Korea will undoubtedly suffer the spending's deflationary effect in full swinging force.
Attacking the chaebol is also unlikely to help South Korea's economic picture. Contrary to popular opinion, their existence is not the result of some evil plot by the undemocratic governments of Syngman Rhee and his successors, it is largely a matter of capital cost.
The cost of capital has a huge, and generally under-recognized effect on economic activity. To take an example, the Scotch whisky industry, with its worldwide exports, did not grow up in Scotland because of the mystically superior nature of its water. Whisky, or a whisky-like drink, is produced in many countries. However, in order to provide the fullest flavor, whisky needs to be aged in casks for a decade or more. This in turn requires tying up capital for a very long period, and makes the cost of that capital by far the largest cost input into the final product. Thus the Scotch whisky industry arose, not because of the water, but because, after the 1707 Act of Union with England, Scotland had the best banking industry and the lowest interest rates in Europe.
Similarly in South Korea, in the early years of economic development after the Korean War ended in 1953, the most expensive economic input was capital, particularly in heavy industry sectors such as steel, oil refining and automobiles. Since the international banking system of the 1950s and 1960s was relatively autarkic, almost all this capital had to be generated domestically. Like Japan both before and after World War II, South Korea found that generating sufficient capital to grow required an oligopolistic corporate and banking system (in Japan, the banks controlled the corporations, in South Korea, it was the other way around.)
Naturally, once South Korea became a major economic power, in the 1980s, the optimal economic structure changed. Today a more competitive economy, with a stronger small business sector and a higher level of entrepreneurship, is appropriate for a much richer country.
The combination after 1997 of Kim Dae-jung's moderately anti-chaebol policies, his (partly International Monetary Fund-imposed) free market reforms and the Asian crisis brought the restructuring South Korea needed. Daewoo went broke. Hyundai continued to grow its share of the world automobile market, while its affiliate Hynix struggled in the semiconductor market (Monday's $4 billion bailout of Hynix is a mistake, for Hynix's bankers, for the South Korean economy and for the world semiconductor market as a whole.) Samsung continued to prosper in electronics and in semiconductors, Lucky-Goldstar continued to prosper in consumer electronics, and Sunkyong established the country's most successful mobile telecom company. In short, as the chaebol founders passed on, and the market freed up, nature took its course, to the great benefit of the South Korean economy as a whole, although the Hynix example suggests that there is still further to go.
The chaebol are yesterday's industrial structure, but they have been enormously successful in developing South Korea's economy, and anti-chaebol policies, if pursued too far, will be wholly counterproductive.
I will not opine on Roh's likely foreign policy, except to say that, just as he appears economically to be a leftist rather than a moderate, so in foreign policy he may prove dangerous to U.S. and Western interests. A "sunshine" policy towards North Korea, if pursued too far, quickly becomes dangerous appeasement. If Roh's actions match some of his rhetoric, towards a regime that is as evil if not as powerful as Nazi Germany in 1938, then we may see the effects, not of an innocent, well-meaning appeasement such as that of British Prime Minister Neville Chamberlain, but of a more sinister appeasement, such as might in 1938 have been practiced by the British Fascist leader Oswald Mosley, in which evil is rewarded by a government that is at least partly in sympathy with it.
Western business was somewhat alarmed when the MDP's Kim Dae-jung, for decades an opposition figure, won power in 1997. In the event, he has been a remarkably moderate and economically sensible president, who has undertaken the reforms South Korea needed and deserves to be remembered favorably. Nevertheless, there are elements in the MDP support base, particularly the notoriously militant South Korean labor unions, which from a business perspective are deeply unattractive.
If we are lucky, Roh's actions will not match his rhetoric, and South Korea will continue to prosper, growing at 5 percent to 6 percent per annum even in a world recession.
If we are unlucky, Roh means what he says. In that event, by the time of the next election in 2007, South Korea's economy may be sick indeed, with minimal economic growth and serious social unrest.
That is, of course, if Roh's foreign policy doesn't produce an even more catastrophic outcome.
(The Bear's Lair is a weekly column that is intended to appear each Monday, an appropriately gloomy day of the week. Its rationale is that, in the long '90s boom, the proportion of "sell" recommendations put out by Wall Street houses declined from 9 percent of all research reports to 1 percent and has only modestly rebounded since. Accordingly, investors have an excess of positive information and very little negative information. The column thus takes the ursine view of life and the market, in the hope that it may be usefully different from what investors see elsewhere.)
