South Korea’s recent economic performance has been disappointing. After 40 years of astonishing 7.9 percent annual GDP growth, the average growth rate dropped to 4.1 percent in 2000-10, and has stood at a mere three percent since 2011. This has many wondering whether South Korea is headed for the kind of protracted deflation and stagnation that characterised Japan’s so-called “lost decades”, from which it is just beginning to emerge.
The similarities between South Korea today and Japan 20 years ago are undeniable. And, in fact, on economic matters, South Korea has, for better or worse, often followed Japan’s example. In this case, Japan’s example can save South Korea – if, that is, South Korea’s leaders take it as a lesson in what not to do.
What Japan got wrong
Japan’s woes are rooted in real-estate and equity bubbles, which were fuelled by monetary expansion aimed at stimulating domestic demand after the 1985 Plaza Accord drove up the yen’s value and hurt Japan’s exports. In the early 1990s, the bubbles burst, leaving the private sector with a huge debt overhang. Add to that sluggish productivity growth, weak demand, and rapid population ageing, and Japan’s situation was dire.
South Korea’s per capita income, just one-fifth of Japan’s in 1970, amounts to almost 95 percent of Japan’s today
At first, Japan’s authorities turned again to fiscal and monetary expansion. But fiscal policies often targeted unproductive projects, such as rural infrastructure construction, and weaknesses in the banking system dampened the effectiveness of monetary stimulus. As a result, the economy grew by just 1.1 percent, on average, in the 1990s, far below the 4.5 percent of the 1980s.
In the early 2000s, Prime Minister Junichiro Koizumi’s government took aggressive action to tackle underlying problems in the financial and corporate sectors. Despite these efforts – not to mention the boost provided by rapid GDP growth in China – Japan’s economy expanded by just 0.75 percent annually, on average, for the entire decade.
Things have been looking up since Prime Minister Shinzo Abe took office in 2012 and launched his three-pronged recovery strategy, dubbed ‘Abenomics’, which entailed bold monetary easing, fiscal expansion, and structural reforms. Stock prices have climbed more than 80 percent. The yen’s depreciation – from YEN78 to YEN123 against the US dollar – has boosted exports of industrial products and, in turn, corporate profitability. Consequently, employment and wages have also increased.
Now, Abe is preparing to augment these efforts with initiatives to address major drags on Japan’s economy. So-called ‘Abenomics 2.0’ entails efforts to raise the fertility rate (free preschool education, support for fertility treatments, and greater assistance for single-parent families) and to mitigate problems associated with population ageing (boosting social security and providing more employment opportunities for retirees).
But Japan’s economy is by no means out of the woods. On the contrary, GDP contracted by 0.1 percent in 2014, and is expected to have grown by just 0.6 percent in 2015. Moreover, despite continued purchases of YEN80trn per year in government bonds, the Bank of Japan has failed to achieve its two percent inflation target. And Japan’s public debt-to-GDP ratio, at 240 percent (and rising), remains the highest in the world.
And Abenomics 2.0 may not succeed, not least because young people, unconvinced that they can support larger families, are increasingly delaying marriage and children. Against this background, many believe that preventing the current population of 127 million from falling below 100 million – Abe’s official goal – will require Japan to accept more immigrants. That is no small matter in a country that places such a high value on homogeneity.
Simply put, while Japan has some reason for hope, its position is not enviable. And, if South Korea is not careful, it could end up in much the same place.
Reliving the 90s
Employing many of the same development strategies – including export-orientated policies and a conglomerate-dominated industrial system – South Korea has been catching up with Japan for four decades. Its per capita income (in terms of purchasing power parity), just one-fifth of Japan’s in 1970, amounts to almost 95 percent of Japan’s today. Over the same period, South Korea’s share of global exports jumped from 0.3 percent to three percent – very close to Japan’s 3.6 percent.
To be sure, significant differences between the two countries remain. South Korea still lags behind Japan in international influence and institutional quality. South Korea ranks 26th on the World Economic Forum’s Global Competitiveness Index, whereas Japan ranks sixth. Based on the gap in GDP per worker with that of the US, South Korea is more than 20 years behind Japan.
Nonetheless, the reality is that South Korea has been experiencing many of the same problems Japan did in the early 1990s, including high levels of household and corporate debt, labour- and financial-market inefficiencies, and low productivity in the service sector. Given a fertility rate of just 1.2 births per woman – among the lowest in the world – South Korea’s labour force is set to shrink by a quarter by 2050, with people aged 65 and over accounting for 35 percent of the total population, up from 13 percent today. This will put serious strain on public budgets.
If South Korea is to avoid Japan’s fate, it must take steps to reduce its household and corporate debt. It also should continue to implement structural reforms aimed at strengthening its labour and financial markets, improving institutional quality, and boosting productivity in services and small and medium-size enterprises.
Taking a cue from Abenomics 2.0, South Korea would do well to provide a better environment for child rearing, including flexible working environments, affordable and high-quality childcare and after-school programmes, and paid maternal and paternal leave. Financial support, such as low-interest loans for newlyweds, could also promote marriage and childbirth.
Japan’s lost decades highlight the importance of treating economic ills with the right medicine, before they become chronic and difficult to cure. If South Korea takes this lesson, and implements the right policies and reforms, being like Japan won’t have to mean sharing its economic fate.
Lee Jong-Wha is Director of the Asiatic Research Institute at Korea University
© Project Syndicate 2016