How Korea Can Avoid Japan’s Economic Mistakes

Around 20 years ago, Japan’s middle-income class started to collapse. Up until the 1980s, Japan had boasted of its “100-million population, all middle-class society.” Afterwards, it was forced to admit that this had degenerated into a “society of disparity.” While 80% to 90% of the Japanese population considered themselves middle class in the 1980s, according to a Seoul University study, this plunged to less than 30% by 2007. The underlying causes of this collapse offer lessons for South Korea, which is now undergoing a transition similar to Japan’s at the start of the 1990s.

There were three major reasons for the profound change in Japan’s economic and social makeup:

During the “lost two decades” starting in 1990, Japan’s economy either shrank, or inched up by just 1% or 2%. Sluggish domestic demand, an aging demographic and a strong yen, and the undermining of the competitiveness of Japan’s exports, all took their toll on growth rates.

Political uncertainties and the absence of strong leadership contributed to social fragmentation. There have been as many as 16 prime ministers in Japan since 1990, while the average term of each prime minister has been just around one year. This instability meant that Japan was unable to iron out a national consensus on its reform plan, or implement reforms in the long run.

The persistent low growth meant many domestic companies struggled or went bankrupt. Massive layoffs ensued, and the labor market turned flexible far too rapidly, with many formerly middle-class workers losing permanent contracts and reliable salaries. Despite high unemployment rates and increasing numbers of irregular workers, the Japanese government failed to overhaul the country’s welfare system so that it would be better able to prevent the dismantlement of the middle class. The Japanese welfare system was poorly suited to the task because it was led largely by corporations. The government’s welfare spending was too small to dole out benefits to those who lost jobs during business restructurings. Even though the Japanese government dared to take deficit financing in order to boost the economy, it mostly injected money into building infrastructure, but didn’t expand spending on welfare much.

In this regard, it is reasonable to worry about the future of Korea, because much of what occurred during Japan’s lost 20 years is currently happening there.

Korea has just entered a low growth stage. The Korean economy is increasing at a rate of less than 3% for the third consecutive year in 2013 – far below its potential growth. The aging demographic is making its economy lose steam, while sluggish domestic demand has continued for over 10 years, since the 1997 Asian financial crisis. Korea differs from Japan, however, in that its exports have been buttressing its growth. But the outlook for the country’s exports isn’t bright due to the strong won, and the slower than expected recovery of the global economy.

Korea is also following Japan’s footsteps in increasing the use of irregular workers, while its lack of a welfare system is stoking social unease and eroding economic vitality.

Both countries’ uncertainties in political leadership are also alike. Conflicts between the ruling and opposition parties are intensifying. The conservatives and liberals are becoming extremely polarized. The president’s leadership is weakening, too. Society hasn’t reached consensus on reform. And even if consensus had been reached, it would be impossible to make consistent efforts to pursue reform due to the current situation of the country.

Given these similarities, how can Korea avoid repeating Japan’s economic mistakes and failures?

Reinstating political leadership is the most crucial factor. Social consensus can only be forged when there is a strong leadership that can broker a grand compromise between the ruling and opposition parties, conservatives and liberals, and employers and laborers. That leadership, at the same time, should be capable of sustaining the consensus and making consistent efforts to do so.

Second, Korea must find a way to pull out of its current low growth trend. Its most urgent task is to invigorate investment. The government needs to encourage businesses by easing regulations, restoring entrepreneurship, and pacifying anti-business sentiment.

Third, Japan’s case should remind Korea of the fact that the rapidly aging Korean society is a critical cause of its lackluster economic growth. The country should come up with long-term and multifaceted measures to raise its birth rate, which is currently the world’s lowest. In addition, Korea needs to revise its immigration policies.

Fourth, while Japan mainly invested in its social infrastructure to boost its economy, Korea needs to focus on its highly educated human capital.

Finally, it is right to increase welfare spending, but the focus should be on a productive welfare system centered on active labor market policies such as supporting training programs for those who change jobs.

If these measures are taken, Korea will still be able to avoid the specter of two lost decades.

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