January 9, 2008

January 9, 2008 | Commentary on Asia

Economic Paradigm Shift

Contrary to assertions that the landslide victory of Lee Myung-bak represented a rejection of ideology; it was, in fact, a mandate for conservative principles, including free market economics.

The collective 63 percent of the vote attained by conservative candidates was a strong electorate rebuff to the progressive movement in South Korea. The voters punished the progressive candidates in retaliation for Roh Moo-hyun's fixation on imposing societal transformation rather than focusing on economic recovery.

Both Lee Myung-bak and Lee Hoi-chang espoused conservative economic principals, which is precisely why their message resonated so strongly with the electorate. The voters saw that a conservative president was more likely to improve the economy, induce domestic and foreign investment, create jobs, and improve South Korean competitiveness against China and Japan.

In today's globalized environment, economic growth and prosperity depend on maintaining and improving an environment in which entrepreneurial activities and innovation can flourish.

Investment capital and entrepreneurial talent flow toward economies with low taxes, secure property rights, sound money, sensible regulatory policies, and greater transparency. Countries with higher degrees of openness and flexibility benefit from the free exchange of commerce and enjoy sustainable economic growth and prosperity.

South Korean over regulation, insufficient transparency, and rising public animosity to overseas companies, however, have driven away foreign and domestic investment, prevented the creation of dynamic small- and medium-size enterprises (SMEs), and discouraged investment by domestic firms.

The five years of the Roh Moo-hyun administration were marked by uneven economic policies, conflicting signals from senior officials, and a preoccupation with ideological redistributionist economic polices

South Korea has made significant strides since the 1997 Asian financial crisis forced the country to open its markets and implement sweeping market-oriented reforms.

But a failure to implement a second wave of reform measures could undermine long-term economic competitiveness against increasingly strong regional rivals

To avoid economic stagnation, South Korea must allow market forces to replace government and organized labor intervention. President-elect Lee should implement the following measures:

Unleash business freedom for South Korea's small- and medium-sized companies. Lee should create an environment in which entrepreneurial activities and innovation can flourish by reducing unnecessary regulatory and administrative barriers that still limit opportunities and hinder corporate investment.

Reforming South Korea's business environment should focus on increasing the competitiveness and profitability of South Korean companies, particularly the SMEs, which account for over 80 percent of employment and 40 percent of exports.

Accelerate corporate governance reform. Though the chaebol are South Korea's strongest economic competitors, their lack of management transparency makes them susceptible to corruption and unresponsive to shareholders who are not family members. These factors often translate into a ``Korea Discount'' that lets Korean shares trade at prices below those of comparable companies elsewhere.

Push the National Assembly to ratify the Korea-U.S. free trade agreement (FTA). The opening of South Korea's markets would provide a renewed chance to improve South Korea's trade freedom and help the economy to lock in further economic reforms. Implementing the FTA would send a powerful signal to foreign and domestic investors and provide a new growth engine to improve competitiveness.

Implement a competitive tax policy to boost economic growth and employment. South Korea's corporate tax rate stands at 25 percent, which is lower than China's and Japan's but higher than Hong Kong's and Singapore's.

The current plan to lower the current tax rate to 20 percent is encouraging and will improve South Korea's fiscal freedom. The tax reform should be also designed to promote transparent and consistent enforcement of the tax law.

Constrain government spending. The proposal to build a $16 billion cross-county canal runs counter to pledges to reduce the level of government involvement in the economy. It will also place a strain on government debt as Korea faces rising pension and health care expenditures brought on by an aging population.

In addition, the economic costs of engaging with North Korea should not be allowed to harm South Korea's overall fiscal health. Any additional economic initiatives with respect to North Korea should be conditioned on clearly delineated political and economic reform measures by Pyongyang.

Enforce the rule of law in dealing with militant labor unions. South Korea's labor market flexibility has long been hampered by high costs and the militancy of the country's labor unions.

Despite noticeable progress in past years, labor laws are still viewed as restrictive by the standards of many other countries in the region. Further labor market reforms though constructive and close public consultations should be pursued, but violent and destructive protests should not be tolerated.

Increase the viability of the service sector. Opening up the service sector would give South Korea another engine of growth and reduce its excessive reliance on exports. The Capital Market Consolidation Act, which liberalized the non-banking financial service sector, was a commendable first step to increase financial freedom and investment freedom, but consistent efforts should be continued to make successful implementation of the act by early 2009.

Reduce balanced regional growth restrictions. The decision to move the government capital from Seoul to a regional area triggered real estate speculation and led to huge government compensatory payments to owners of appropriated land. The number of government agencies should be reduced and a portion of the land instead made available for business use.

South Korea possesses enviable economic strengths. It enjoys a stable political system, a strong cultural work ethic, a highly educated workforce, and a history of technological innovation. But, the South Korean economic engine requires a major overhaul, not just tinkering under the hood.

Lee must quickly implement these recommended measures to allow market forces to replace government and labor intervention. Doing so would unleash the full potential of the South Korean people and significantly improve the country's economic competitiveness.

Bruce Klingner is senior research fellow for Northeast Asia in the Asian Studies Center at the Heritage Foundation (heritage.org).

About the Author

Bruce Klingner Senior Research Fellow, Northeast Asia
Asian Studies Center

First appeared in Korea Times