OECD Economic Surveys: Korea 2018
Executive summary
Abstract
Short-term economic prospects are good…
The economy rebounded in 2017 after several years of subpar growth (Figure A). The upturn was led by business investment and a continuing boom in construction driven by housing investment. An uptick in world trade and surging demand for semiconductors boosted Korean exports. A supplementary budget in mid-2017 also supported growth. However, high household debt and labour market slack continued to limit private consumption. Higher oil prices pushed inflation toward the 2% inflation target and the current account surplus remains large.
Figure A. The economy is projected to grow around 3% a year in 2018 and 2019
Source: OECD Economic Outlook: Statistics and Projections (database).
The government aims to achieve “income-led growth” driven by job creation. Public employment is to be boosted by around 34% from a low base over five years. Government spending is to rise in line with output growth, but the composition will shift. The share of outlays on social welfare and public employment will increase while that on investment in infrastructure and R&D falls. The government plan to raise the minimum wage to KRW 10 000 – implying a cumulative increase of 54% from 2017 – would also boost household income.
Output growth will remain close to Korea’s 3% potential growth rate in 2018 and 2019. Sustained growth of world trade will boost Korean exports, offsetting some slowing in domestic demand due to construction investment. The tightening of loan-to-value and debt-to-income ratios applied to mortgage lending has slowed the growth of residential property orders (Figure B). However, the income-led growth strategy will support household income and private consumption. Given its projection of steady domestic demand growth, the Bank of Korea raised its policy interest rate in November 2017 from a record low to stabilise inflation at its 2% target level over a medium-term horizon.
Figure B. Lending to households and residential property construction orders are slowing
Year-on-year percentage change
Source: Financial Supervisory Commission; Bank of Korea.
… but Korea faces risks, including high household debt…
Korea is vulnerable to shocks, given its dependence on construction and a few key industries, notably semiconductors. The government’s plan to promote innovation could lead to a broader-based recovery and faster growth. A rapid rise in wage costs could weaken competitiveness if productivity gains fail to keep pace. Protectionist pressures would affect exports and business investment.
Household debt has risen to 180% of household disposable income, far above the OECD average, in part due to structural factors. The government launched a comprehensive strategy in late 2017 to address household debt, focusing on new regulations on mortgage lending. It seeks to reduce household debt growth to 8.2% per year, which would still imply a further rise in household debt relative to GDP. On the other hand, the numerous housing-related measures during the past year might turn the slowdown in housing investment into a decline. The risk to the financial sector is limited, however, as the delinquency rate on household loans is low and the capital adequacy ratio for banks is high. Moreover, 70% of household debt is held by the top 40% of income earners and household debt is backed by a rise in assets (housing). Still, low-income households may be vulnerable in a context of rising interest rates.
Korea’s traditional model of growth led by exports produced by large business groups, known as chaebols, is losing steam. Real GDP growth is slowing toward the OECD average (Figure C), while Korea’s real per capita income is one-third below the top half of OECD countries (Figure D). The large income gap reflects low labour productivity, which is 46% below the top half in the OECD.
Figure C. Korea’s output and export growth have slowed
Source: OECD Economic Outlook: Statistics and Projections (database).
Figure D. Labour productivity is low in Korea and labour inputs are high
Korea relative to the top half of OECD countries in 2016
Source: OECD Economic Outlook: Statistics and Projections (database).
Unbalanced growth driven by exports and manufacturing has led to economic and social polarisation. Productivity in small and medium-sized enterprises (SMEs) in manufacturing has fallen to less than one-third of that in large firms. SMEs are concentrated in services, where productivity is less than half of that in manufacturing. Large productivity gaps are reflected in wide wage dispersion. Workers in the bottom 10% of the income distribution have seen virtually no wage growth during the past two decades. Consequently, wage inequality is high and increasing in Korea (Figure E).
Figure E. Wage inequality is high and increasing in Korea
Ratio of the 90th percentile to the 10th percentile
Source: OECD Earnings Distribution (database).
… reflecting weaknesses in the large business groups and SMEs
The government has placed reform of the business groups near the top of its agenda. The groups have played a key role in Korea’s rapid development, though the slowdown in Korea’s export growth since 2011 (Figure C) raises concern. The groups remain leading players, with the top 30 accounting for about two-thirds of shipments in manufacturing and a quarter of sales in services. The groups continue to diversify, increasing the number of affiliated firms since 2000 (Figure F).
Figure F. The number of firms affiliated with the large business groups is still rising
Source: Korea Fair Trade Commission.
The concentration of economic power appears to stifle entrepreneurship and firm creation. Group‐affiliated firms rank first in business lines accounting for more than two-thirds of manufacturing sales. In addition to the impact on competition, ties between the groups and politicians have been a source of corruption. Since the 1980s, the groups have been subject to special regulations. For example, cross-shareholding between firms in the same business group is prohibited and there are regulations on intra-group trading. Nevertheless, the regulations have failed to resolve the key concerns related to the groups.
The groups are controlled by their founding family, even though their ownership share has fallen to an average of only 2% in the four largest groups. The families maintain control through shareholding among the groups’ affiliates, allowing them to override the interests of the affiliated firms’ shareholders, in the context of weak corporate governance. Outside directors are mandatory, but dissenting votes at board meetings are rare. The lack of transparency contributes to the low price-earnings ratio for Korean firms – the so-called “Korea discount” (Figure G).
Figure G. The price-to-earnings ratio of Korean firms is relatively low
Source: Bloomberg.
The government aims to make SMEs a driver of innovation. The trickle-down effects from large firms have weakened as they have become more internationalised and focused on capital and technology-intensive products. Enhancing the dynamism of the SME sector, which accounts for the largest share of employment among OECD countries, is essential for economic inclusiveness and poverty reduction.
Productivity in SMEs is held back by a number of factors. First, product market regulation in Korea, which was the fourth-most stringent in the OECD in 2013, is concentrated in services. SMEs account for around 90% of employment in services. Moreover, the uncertainty, complexity and inconsistency of regulation burden smaller firms more. Second, SMEs’ R&D is low and the share that participates in global innovation networks is the second lowest in the OECD. Third, the share of small firms that participate in global value chains is the lowest in the OECD. Fourth, Korea ranks low in terms of entrepreneurship (Figure H), which does not have a very positive image in Korea. Entrepreneurship opportunities are especially limited for women. Fifth, the creation and growth of small firms is also constrained by a lack of market-based financing.
Figure H. Korea ranks low on the Global Entrepreneurship Index
Source: Global Entrepreneurship Index (2018).
Korea faces well-being challenges
Korea ranks below the OECD average on subjective well-being, despite high scores on personal security and education and skills (Figure I). Korea scores low on the gender-wage gap, working hours and air pollution.
Figure I. Well-being is low in a number of areas
Note: Korea’s performance relative to the median values in the OECD area. The index median = 100.
Source: OECD Better Life Index, www.oecdbetterlifeindex.org.
The large gender wage gap and long working hours inhibit female employment (Figure J). Other factors are weak enforcement of the right to maternity leave and women’s concentration in low-paid non-regular jobs, despite their relatively high level of education. Non-regular workers earn a third less than regular workers, face precarious employment, and receive less firm-based training and social insurance coverage. Labour market dualism, along with labour market mismatch, keeps the youth employment rate well below the OECD average. Removing obstacles to employment would help cope with population ageing (Figure K).
Figure J. Korea’s employment rate was below the OECD average in 2016
1. As a percentage of the working-age population.
Source: OECD Employment and Labour Market Statistics (database).
Older persons face a number of challenges. Workers are forced out of firms at around age 50, given their relatively low skills and seniority-based wages. Those who remain in the labour market generally end up in self-employment or temporary jobs. The early departure from career jobs, combined with the decline in family support and the weakness of other private and public sources of income leads to poverty among the elderly. Indeed, the relative poverty rate of those over age 65 is 45.7%, far above the 12.9% OECD average.
Average air quality in Korea is the worst in the OECD and deteriorating. Korea has the OECD’s second-highest growth of greenhouse gas emissions since 2000. In per capita terms, they now exceed the OECD average. Low electricity prices hamper efforts to reduce energy demand and act as a barrier to renewables, whose share of primary energy supply is the lowest in the OECD. In addition, fossil fuels remain heavily subsidised. In the absence of policy measures, the number of premature deaths due to outdoor air pollution is projected to almost triple by 2060, placing Korea among the worst affected countries. Air pollution reflects Korea’s energy-intensive economy and is exacerbated by dust blown in from abroad, particularly China. The government has recently launched a five-year plan against fine dust.
Figure K. Korea faces the most rapid population ageing in the OECD
Note: Population aged 65 and over as a per cent of the population aged 15 to 64.
Source: OECD Demography and Population (database).