Since taking office in May 2017, South Korean President Moon Jae-in has worked hard to secure a détente on the Korean Peninsula. He has met with North Korean leader Kim Jong-un three times this year, and agreed to convert the Korean Armistice Agreement into a full peace treaty, improve inter-Korean exchange and cooperation, and work toward “complete denuclearization” on the peninsula. On the economic front, however, Moon has been less successful. And that weakness is increasingly undermining his leadership.
South Korea’s economy is struggling because its dependence on exports leaves it vulnerable to rising risks in major external markets – in particular, the United States, with its protectionist policies, and China, where growth continues to decelerate. Already, major export industries – including shipbuilding, steel, automobiles, and even mobile phones – are rapidly losing competitiveness vis-à-vis Chinese producers. Domestic industries are also hampered by weak productivity growth, inadequate labor-market efficiency, and the gulf between the country’s chaebols (family-owned conglomerates) and smaller firms.
Rather than address the structural problems afflicting South Korea’s economy, however, Moon has focused on redistribution. His signature economic policy, “income-driven growth,” aims to use minimum-wage hikes – 16.4% in 2018 and 10.9% in 2019 – to boost domestic consumption by channeling more money to low-income households.
But this sharp wage increase hit small and medium-size enterprises (SMEs) and self-employed businesses hard. Despite government subsidies and cheap loans, soaring labor costs proved too much to bear amid the economic downturn, and these companies were forced to reduce hiring.
Given that SMEs employ 88% of private-sector workers, and that more than 25% of South Korea’s workers are self-employed, it should come as little surprise that the economy added only 17,000 new jobs in the third quarter of this year. In the third quarter of 2017, the economy added 279,000 jobs.
Employment continues to decline in the manufacturing sector and traditional service industries, such as wholesale and retail trade, accommodation, and food service. The unemployment rate, especially among young people, has risen. Meanwhile, Moon’s approval ratings have declined, from 79% in June to 58% today.
Moon’s administration has also been eager to increase social-welfare expenditure. The government’s proposed 2019 budget would be 9.7% larger than in 2018, with welfare programs receiving the largest share of funds (34%).
South Korea does need to strengthen its social safety net for the vulnerable and increase investment in childcare and education. But spending more on, say, public-sector jobs would bring only temporary benefits; in the long term, such spending would weaken work incentives and undermine corporate investment, which is already on the decline.
Moreover, while South Korea can afford to increase public spending today, raising expenditure without paying careful attention to resource allocation will eventually undermine fiscal sustainability. After all, South Korea already has major new expenses on the horizon, beginning with rising health-care and pension costs, owing to a rapidly aging population.
Projects supporting inter-Korean economic cooperation will also carry considerable costs. Moon has agreed to build transport and energy links between North and South Korea, as well as provide financial assistance for the North’s economic development. Without substantial aid from other developed countries and international financial institutions, such as the World Bank and the Asian Development Bank, South Korea’s government will have to foot the bill.
Of course, the private sector could – and should – also be engaged. But chaebol leaders made clear during a visit to Pyongyang in September with Moon that they are reluctant to get involved, given the lack of legal and institutional safeguards for foreign investment. It does not help that the US embassy in Seoul has reportedly warned these conglomerates against violating international sanctions on the North.
According to Moon, the costs will be more than worthwhile, because inter-Korean economic cooperation could kick-start economic growth, with North Korea serving as a new market for South Korean businesses. But, for this to happen, the North must capitalize on the combination of its natural resources and cheap labor with South Korean money and technology to secure strong growth. Given how difficult the economic-reform process will be, South Korea may not experience net economic gains from cooperation with the North for many years.
Moon has attempted to pursue one other economic objective: “innovative growth.” But significant progress has yet to be made, owing partly to excessive business regulations and labor-market inefficiencies. South Korea’s smaller, more efficient firms are still at a huge competitive disadvantage vis-à-vis the country’s long-dominant conglomerates.
What South Korea needs are policies to improve service-sector productivity, strengthen SMEs, and increase labor-market efficiency. Only with such an approach can Moon hope to boost the economy’s growth potential, create decent jobs, reinforce the economy’s fundamentals, and bolster resilience to external downside risks.
Moon seems to be putting most of his eggs in the North Korean basket. But achieving lasting peace on the Korean Peninsula will not be easy. Polls show that a majority of South Koreans remain skeptical about denuclearization. Moon’s conciliatory approach toward the North is relentlessly criticized by opposition parties in the National Assembly, and has caused tension with the US government.
In any case, South Koreans are currently focused less on developments in North Korea and more on their own economic concerns. Addressing those concerns – and thus ensuring continued support for inter-Korean cooperation – will require practical solutions to structural problems, not more redistributive policies.