Sustaining the Miracle on the Han River

Vincent Koen, Christophe André, Jinwoan Beom, Axel Purwin, Byungjun Kim [OECD]

When Korea joined the OECD in 1996, it had already enjoyed more than three decades of outstanding growth, based on an export-oriented economy served by a hard-working and increasingly well—educated workforce and high saving and investment rates. The so-called Miracle on the Han River (Han-gang) had transformed one of the poorest countries in the world at the end of the Korean War into an economy generating a GDP per capita comparable to that of some European countries. Nevertheless, it was still about 30% below the OECD average in 1996. Over the past 25 years, Korea has carried out major economic reforms, aligned its policies on OECD best practice in many areas, increased its integration into the global economy and enhanced its technological and human potential further, leading to the convergence of its GDP per capita to the OECD average (Figure 1).

While the economy is rebounding strongly from the COVID-19 crisis, Korea will need to overcome a number of obstacles to continue growing faster than the OECD average and catch up with the leading OECD countries like the United States. A rapidly ageing population requires better mobilising labour resources, notably from women and youth, who are generally highly educated and skilled, but whose talent and abilities are often under-utilised in the labour market. Prolonging the careers of older workers, notably through labour market reform and lifelong learning, is also decisive to boost labour input and productivity, as well as to reduce poverty.

World-class technology is fostering rapid productivity growth for the big firms, notably in the ICT sector, but large chunks of the economy are still lagging behind. To reduce the aggregate productivity gap with the leading OECD economies, SMEs (small and medium enterprises) and the service sector will need to become more productive. This will necessitate investments in technology and skills and policies fostering competition. The Korean New Deal, with its digitalisation, green and social safety net pillars, paves the way for tomorrow’s growth. As over the past 25 years, Korea can draw inspiration from successful reforms in OECD member countries to design the best policies to achieve its goals. OECD countries, as well as non-members, can also learn from Korea’s outstanding economic performance to enhance their growth and innovation potential.

This chapter is organised as follows. The next section examines how OECD membership supported Korea’s globalisation policy agenda set out in the mid-1990s. The third section reviews the reforms that made Korea more resilient after the painful recession associated with the 1997 Asian crisis. The fourth section examines Korea’s growing role in global economic cooperation. The last section outlines the challenges and opportunities that Korea will face over the coming decades.

OECD membership supported the globalisation policy agenda

Joining the OECD was part of the broad Segyewha (globalisation) agenda of President Kim Young-sam, Korea’s first civilian president in over three decades. In 1996, Korea’s real GDP was 25 times larger than in 1960, one of the most outstanding economic achievements in world history. However, the growth model where strong government leadership dominated market forces was starting to show its limitations, as the economy was becoming more diversified, income and education levels were rising rapidly and the population aspired to better shared prosperity following the return to democracy. Furthermore, the 1990s saw an acceleration in globalisation, with the fall of the iron curtain in Europe and the rising role of the BRICs (Brazil, Russia, India, China, and South Africa) and other emerging markets in the world economy. Korean exports faced tougher competition. To continue its convergence to the highest-income countries, Korea had to embrace globalisation and develop further into a knowledge-based economy producing higher-quality goods and services. The OECD, which at that time was broadening its membership with the accession of Mexico and several Eastern-European countries, was in a good position to help Korea move towards a new stage of its economic rise. At the same time, Korea’s membership reinforced the OECD’s increasingly global stature and brought its members new opportunities for cooperation and mutual learning.

The Korean government outlined an ambitious reform agenda to move towards a more market-based economy in the mid-1990s, incorporating recommendations from the first two OECD Economic Surveys of Korea, published in 1994 and 1996. Two guiding principles for reform were to increase the economy’s exposure to competitive forces and to introduce more effective governance structures into financial institutions and the corporate sector. In addition, moving towards a more flexible labour market, while at the same time strengthening social protection, was necessary to facilitate the reallocation of resources across the economy and create more and better job opportunities. Employment insurance was introduced in 1995, albeit on a limited scale, and the first OECD Jobs Strategy (1994) provided further guidance (OECD Economic Survey of Korea 1998).

Unfortunately, Korea was only at the beginning of its reform process when it was hit by the Asian financial crisis, which originated in Thailand in 1997 and spread rapidly to the whole region.

The painful 1997 crisis paved the way for a more resilient and inclusive economy

The Korean economy was vulnerable to an external financial shock due to excessive corporate debt, which was largely short-term and denominated in foreign currency. The big Korean conglomerates, the chaebols, had borrowed heavily in previous years to expand in a wide range of activities, with insufficient consideration for profitability. In 1996, 20 of the 30 largest chaebols had a rate of return on invested capital below the cost of capital. The ratio of debt to total assets in manufacturing firms rose to 317% in 1996 and climbed to almost 400% in 1997 (Figure 2). The debt ratio of the chaebols was even higher, exceeding 500% at that time. The strong ties between industrial groups and banks were hampering adequate credit scrutiny, resulting in low bank profitability and ultimately a high share of non-performing loans when the crisis hit. Foreign debt grew rapidly. The Asian financial crisis triggered a reassessment of risk by international investors and capital flight.

At the end of 1997, the Korean won’s exchange rate collapsed and IMF emergency assistance had to be requested to avoid a foreign debt default and stabilise financial markets. Bilateral loans by several OECD countries also contributed to restoring investor confidence. Nevertheless, GDP fell by more than 5% in 1998 and the unemployment rate rose to more than 7%, from a pre-crisis level of around 2%. The social cost proved very high in a country where the social safety net was still underdeveloped. Nevertheless, thanks to the reaction of the authorities and the efforts of the Korean people, such as the nationwide gold-collection campaign to repay the foreign debt, the country emerged from the crisis faster than other Asian economies, returning to its GDP per capita pre-crisis peak after just two years.

The crisis provided an impetus to deepen and accelerate the reform agenda that had been set when joining the OECD. Corporate governance improved, the chaebols restructured, refocused on their core activities and regained competitiveness. By end-1999, 14 of the 30 top business groups in 1997 had gone bankrupt or entered workout programmes. The debt ratio of manufacturing companies was down to around 100% by 2004, and rose only modestly, to about 120%, following the 2008 global financial crisis, which Korea passed without going into a lasting recession. The manufacturing debt ratio subsequently decreased to 73% in 2019, when total borrowing and bonds payable represented 23% of total assets. The interest coverage ratio of manufacturing firms, which measures their ability to service their debt, strengthened markedly (Figure 3). The soundness of corporate balance sheets greatly helped the Bank of Korea stabilise financial markets when the COVID-19 crisis hit and allowed companies to continue investing to take advantage of the opportunities offered by the recovery, notably in semiconductors and green technologies.

Openness to trade and investment also increased following the 1998 crisis. Korea’s traditionally hostile attitude towards FDI, which had led to excessive reliance on volatile capital flows, evolved, with benefits in terms of macroeconomic stability, as well as management quality and transfer of technology. The country continued to invest heavily in skills and R&D investment started to increase steadily (Figure 4), which boosted the production of higher value products, notably semiconductors, in which Korea now stands among the world leaders. In 1998, under President Kim Dae-jung, Korea decided to open its gate gradually to foreign culture, notably Japanese popular culture. The lifting of restrictions on cultural imports led to massive investments in cultural industries to enable them to face the new competition, ultimately giving rise to the Hallyu, the Korean wave. Today, cultural products are a major export and Korean culture shines around the world, through K-pop, K-dramas, cinema and K-food in particular.

Kim Dae-jung, the prominent democracy and human rights activist, elected as president in February 1998, implemented ambitious reforms to strengthen the market economy, but also pushed forward “productive welfare,” based on the principles that welfare is a right, but should help recipients to become self-sufficient and contribute to economic growth. Beyond providing minimum assistance in the very challenging economic times of the Asian financial crisis, when close to two million people had become unemployed while the social safety net was almost non-existent, the policy focused on education and training to improve jobseekers’ opportunities. Korea drew inspiration from the employment strategies pursued in many OECD countries, notably in Europe. Although starting from a very low point, the social safety net was gradually extended over the following decades, even though effective coverage remains insufficient to this day.

The economic reforms implemented since the mid-1990s greatly strengthened the resilience of the Korean economy, which weathered the 2008 global financial crisis and the COVID-19 crisis better than most other OECD countries. While the impact of the pandemic was mitigated by an outstanding health policy response, strong economic institutions also made it possible to promptly stabilise financial markets and to provide ample and timely fiscal support.

Korea has come to play a prominent role on the economic world stage

As the Korean economy grew stronger, the role of Korea in international economic cooperation increased. As a member of the G20, Korea is actively engaged in shaping policy around global issues, such as international trade, financial stability and climate change mitigation. As a “middle power”, an economy with an exceptional development trajectory, and a country that has moved from an aid recipient to a donor, Korea is particularly active in bridging the gaps between leading economies and developing nations, notably in Southeast Asia.

The 2008 global financial crisis was a key moment for the global economy and elicited a coordinated policy response. President Lee Myung-bak proposed a standstill agreement in trade and investment restrictions at the first meeting of G20 leaders in Washington D.C. in November 2008. Korea acted to address liquidity shortages in Asian countries. In June 2009, Prime Minister Han Seung-soo, who had been Deputy Prime Minister and Minister of Finance when Korea joined the OECD in 1996, chaired the meeting of the OECD council at ministerial level. The meeting, under the theme “The Crisis and Beyond: For a stronger, cleaner, fairer world economy” allowed OECD leaders to design cooperative solutions to address the global financial crisis and climate change, which as Prime Minister Han highlighted, required “creative solutions, immediate remedy and broad intervention.” As Chair of the G20 in 2010, Korea also took an active role in coordinating global financial cooperation, both between advanced economies and with developing countries.

In recent years, while globalisation was increasingly challenged globally, Korea has continued to display a strong commitment to free trade and international economic cooperation. In November 2020, it signed the Regional Comprehensive Economic Partnership (RCEP), the world's largest free trade agreement, linking countries with a combined GDP amounting to a third of the world's total. The agreement involves the 10 members of the Association of Southeast Asian Nations (ASEAN) as well as Korea, China, Japan, Australia and New Zealand to strengthen trade and economic cooperation in the Asia-Pacific region. Korea also continues to expand its network of bilateral trade agreements, most recently with Central American countries, Indonesia, Israel and the United Kingdom (to preserve bilateral trade relations after the Brexit).

The invitation to President Moon Jae-in to participate in the 2021 G7 summit highlights the world leaders’ appreciation that Korea can make a great contribution to addressing global challenges. Korea’s response to the COVID-19 pandemic has been outstanding, containing the spread of the disease, the death toll and the economic damage. Real GDP contracted less than 1% in 2020, setting an example for other OECD countries. Furthermore, Korea helped countries around the world address the pandemic by exporting its “K-quarantine” model, based on the so-called 3Ts, “tracing, testing and treating”. Korea exported test kits around the world and donated some, notably to Southeast Asian countries, while providing health management support to other developing countries.

Korea also plays a key role in the provision of semiconductors, which are key to the smooth functioning of global value chains and are of strategic importance amid rising global geopolitical tensions. Korean firms have recently announced new foreign direct investments, notably in the United States, to build up production capacity.

Korean technology can also make a major contribution to greening the global economy, with for example Korean manufacturers well positioned on the development of electric cars and batteries, but also on hydrogen. New investments in technology, including from the Green New Deal, will contribute to finding solutions to foster sustainable growth globally. Progress in green technologies will boost Korean exports and at the same time have a great potential to improve environmental quality at home, provided the right economic incentives are in place, including in the financial sector. Creating a roadmap for improving the consistency, comparability and quality of climate-related risk reporting by listed companies and financial institutions would help. So would stepping up policy measures to support capital allocation in line with a low-carbon transition and to boost investment in renewable energy.

In the wake of the 2021 G7 summit, President Moon Jae-in emphasised once again Korea’s commitment to act as a bridge between advanced and developing countries. Korea is playing a crucial role in engaging non-OECD Member countries to share best practices and promote economic development. Since taking on the Co-chairmanship of the OECD Southeast Asia Regional Programme (SEARP) in 2018, it has made critical contributions to bring Southeast Asian countries closer to the Organisation, supporting their economic policy priorities and regional integration efforts. Korea will host the Programme’s Ministerial Conference in 2022, under the theme “People-centered future: Partnership for smarter, greener and more inclusive ASEAN”. This effort is in line with the OECD’s commitment to engage with emerging economies expressed in the OECD Convention and its 50th anniversary vision statement, and reflects the current Korean administration’s New Southern Policy to strengthen ties with 10 ASEAN Member States and India. This offers paths for further cooperation in view of strengthening the OECD’s global reach, not least in the Asia-Pacific region, whose weight in the global economy is bound to continue growing.

The next 25 years: Catching up with the OECD leaders?

By 2020, Korea was among the ten largest economies in the world and its GDP per capita was close to the OECD average and comparable to that of countries like Japan and the United Kingdom, albeit still about 30% below the US level. Growth is gathering pace in 2021, pulled by strong exports, especially of semiconductors and cars.

Nevertheless, challenges remain. With the fastest ageing population in the OECD (Figure 5), Korea will need to better mobilise its labour resources and enhance productivity to ensure continued growth. The 2020 OECD Economic Survey of Korea shows that Korea has the resources to meet these challenges and continue to catch up with the most successful OECD economies over the next decades. Drawing from OECD countries’ best practices will help Korea achieve this goal. The new OECD Jobs Strategy suggests ways to boost employment and foster inclusive growth, notably by improving job opportunities for youth and women, as well as the quality of jobs for older workers. Digitalisation, which has been speeded up by the pandemic, offers huge opportunities to raise productivity growth and, provided diffusion widens, increase inclusiveness. For example, digitally-enabled financial services can improve economic resilience and foster new innovative digital markets and products such as FinTech-enabled SME lending and blockchain-based finance.

Less than half of Korean youth aged 15-29 were employed before the COVID-19 crisis, the fifth lowest share in the OECD and the pandemic has made matters worse. Entry in the job market is particularly challenging for young men (Figure 6, first panel). Many aspire to work in the public sector or large companies, where they can get higher pay and better job security, while many SMEs are struggling to recruit qualified workers, which hampers their development. Korea can draw on the experience of other OECD members to improve job prospects for youth, including through vocational education and training, job counselling, and active labour market policies.

Women’s employment rate is M-shaped (Figure 6, second panel). While it is close to the OECD average at about 70% in the 25-29 age group, it drops sharply thereafter, as many women exit the labour market when they have children. The employment rate recovers around age 50, but remains much lower than for men. In addition, women are often employed as non-regular workers, with limited social protection and low pay. The gender wage gap exceeds 30%, the highest level in the OECD. The pandemic has worsened women’s employment prospects further, as they are over-represented in activities like retail trade, accommodation and restaurants, which have been the most affected by the crisis and are recovering only slowly. Korean women have increasingly high qualifications, with the highest 25-34 year-olds tertiary graduation rate in the OECD. Offering them better job opportunities is crucial to boost Korea’s growth potential. Allowing better work-life balance could also contribute to raising the fertility rate, which is the lowest in the OECD at 0.84 in 2020. To design gender-friendly policies, Korea needs to draw inspiration from other OECD countries, such as the Nordic countries.

Improving job quality for older workers is also key to lifting Korea’s aggregate productivity and alleviate old-age poverty. Because of low pension entitlements, partly reflecting the late introduction of the National Pension Scheme, and weak compliance, 58% of men and 35% of women aged 65 to 69 are still working and the average full retirement age is around 72. However, most of them are forced to leave their career job at a relatively early age and tend to move to jobs with lower pay and productivity. Abolishing the mandatory retirement age and the seniority-based wage system, promoting greater wage flexibility, better work-life balance and lifelong learning could boost the level and quality of employment of older workers. Many OECD countries have set examples in prolonging workers’ careers.

More generally, a dual economy hampers Korea’s economic performance. Korea’s aggregate productivity remains about 30% below the OECD average, as the productivity of small firms and service-sector firms lags far behind that of the leading companies. Korea’s ICT manufacturing productivity is far higher than in other industries, with a much wider gap than in the average OECD country (Figure 7). Non-ICT manufacturing also enjoys a larger relative productivity advantage than the OECD average, albeit much smaller than in ICT. Conversely, there is wide scope to increase productivity in services, especially in ICT services, which are knowledge-intensive and tend to be more productive than other services. This will require broader and faster technology diffusion. Use of advanced IT technologies, like cloud computing and big data is lagging in SMEs, which face difficulties in recruiting skilled workers and managers, as well as in training their workforce. Scale-up success is limited, despite extensive government R&D support. Product market regulations also need adjustments to promote competition and adapt to rapid technological change. The regulatory sandboxes, which allow firms in new technologies and new industries to test their products and business models without being subject to all existing legal requirements, are a promising step in the direction of enhanced responsiveness and competition.

The Korean New Deal, which aims at boosting digitalisation, greening the economy and reinforcing the social safety net, has the potential to open a new era of growth, to prolong the Miracle on the Han River. The next 25 years will offer the opportunity for Korea to use its technological, human and economic potential to catch up with the top OECD economies. Reaching this goal will require designing policies to adapt to a fast-moving economic and technological landscape. Adapting to an increasingly multipolar and digitalised world facing rapid climate change will be challenging, for Korea like other OECD members, but they surely can learn from each other to build a better world.

Korea’s economic journey holds important lessons for Asia-Pacific countries, which will help the OECD strengthen its engagement and outreach within the region. As already emphasised, the “Land of the Morning Calm” is often a bridge between advanced and emerging economies. Korea is also an enthusiastic promoter of free trade, multilateralism and international cooperation, core values of the OECD, which it diffuses throughout the most dynamic region in the world. Over the next 25 years, no doubt Korea will continue to work together with the OECD to promote these values in the Asia-Pacific region and strengthen ties with other OECD members.