The Peninsula

The Culture of Borrowing: How Korea’s Hyper-emphasis on Achievement Created a Mountain of Debt

By Clare Hubbard

The global sensation of “Gangnam Style” depicts Korea as a society of superfluous spenders fueling an accelerating economy. Currently, that economy is showing the same signs of downturn that occurred before the 2008 global economic crisis. While South Korea was able to avoid most of the global economic crisis in 2008, its current borrowing rate is seen as unsustainable by economists.  As of September 2012, Korean households hold a debt to income ratio of 155%, meaning that the average South Korean household spends one and a half times what it brings in. This high rate of borrowing, alongside the inability to pay back loans, is due in large part to Koreans’ hyper-emphasis on success, or, in the case of failed success, at least looking the part.

South Koreans have always been competitive about achievement in the spheres of education and career.  And what is the best way to signal your success? Through the ownership and display of luxury goods.  Koreans have become so obsessed with proving their achievement that overspending has become a major problem. Similar to the U.S. debt crisis, where people spent more than their incomes could provide (specifically, buying houses they could not afford then turning to loan companies that demanded a high interest rate), Korea is spending money on sectors that reflect their ambition and achievements. This experience is being called “competitive spending,” and Koreans view the opportunity cost of spending now to be more important than saving for later. Competitive spending is seen in three sectors of Korea’s culture of achievement: education, small business ownership and luxury goods.

1. Education

Korean parents are willing to shell out big bucks in order to give their children a scholastic edge over their peers. Large amounts of money have been spent on after school academies called hagwons, which focus on the study of subjects like math, science, English and arts. About 80% of elementary through high school students attend hagwons.  The common perception is that if a student is not attending a hagwon they will fall behind academically, and parents are motivated to spend a significant portion of their income on the chance to keep their children academically competitive.  Koreans spend 2% of their GDP for this after-school tutoring.   It is not unusual for middle and high school students to get home as late as 1 AM on a school night after a hagwon session.  Along with hagwons, money is also being spent on expensive English language camps held during winter and summer breaks. “Education is a fixed expenditure for Korean parents, even when household income shrinks,” said Oh Moon-suk, executive director at LG Economic Research Institute.

Of course, all this money is invested into a student’s education so he or she can get into an elite SKY university (SKY stands for the top three universities in Korea: Seoul National University, Korea University and Yonsei University). About 80% of Korean students attend university, and tuition costs are the responsibility of the parents. While tuition in Korea is relatively inexpensive compared to American universities, many Koreans go abroad for college, forcing parents to take out loans.

2. Small Businesses

Another large portion of household debt comes from personal loans that are taken out to start small businesses.  Small businesses represent one third of the Korean workforce. These small businesses (SMEs) compete with chaebols, family-owned conglomerates that account for most of the economic growth in South Korea. The five largest chaebols accounted for 55.7% of South Korea’s GDP in 2010. In fact, the majority of small business owners are middle-aged workers who were laid off by chaebols and replaced by younger workers.  The laid off workers often turn to starting a new business to generate income and then are forced to compete in the markets that are mostly controlled by chaebols. If the competition with the chaebol is too much for an SME and their business fails, the loan repayment can become difficult, if not impossible.

3. Luxury Goods

Whether you are failing or succeeding economically, Koreans spend a significant portion of their incomes on brand-name merchandise and expensive leisure activities. The pressure to create the perception of success has turned Korea from a nation of savers to one of the most uninhibited group of borrowers in the world, all in less than twenty years. To indicate success, Korean consumers will buy luxury handbags, fancy cars, foreign travel, imported whisky, designer shoes and new apartments. Everyone hopes to portray a well-heeled image through the clothes they wear, the restaurants they eat at and the countries they travel to.  There is a reason that lending service advertisements are posted strategically next to ads on public transportation for plastic surgery and English lessons.  In order to maintain a certain status, Koreans are willing to spend money on brand-name goods no matter what their household income is.

Getting a sizeable loan from a Korean bank is difficult. In the United States, home mortgages are often 80% to 90% of house prices, but in Korea, a mortgage cannot be worth more than half the home’s value.  When banks do give out loans, interest rates are in the range of 4-6%. Because of societal pressures to spend and banks’ unwillingness to provide large loans, Koreans are turning to “non-banks,” which  charge up to 39% in interest. This 39% interest rate is regulated by the government, but if “non-banks” wish to charge more they give up their licenses and continue to operate. If borrowers are unable to pay back their debt, “non-bank” representatives have been known to come to their homes at night and threaten physical assault. Some loan companies have even set up women in prostitution services so they can pay off their debt.

Partially to blame for the current debt crisis are past government policies that encouraged borrowing.  After the Asian financial crisis in 1997, the South Korean government made low-cost loans available for the purchase of apartments. The government also encouraged credit card use to reduce tax evasion from unaccounted cash transitions.

South Korean regulators are trying to create a “soft landing” by creating policies that force consumers to be more cautious about their spending.  This plan includes a wide range of limits on bank lending, tax breaks for homeowners who switch from adjustable -rate to fixed rate mortgages, and getting banks to toughen their scrutiny of borrowers’ credit scores. In January, Kim Seok-dong, chairman of the Financial Services Commission, made a public relations effort to promote the use of debit cards over credit cards. As much as 91% of card purchases are made with credit cards, compared to 9% with debit cards. The government has also been cracking down on criminal actions “non-banks” take to get their loans repaid.

Economists have debated what this level of spending means for the development of Korea.  Some believe that a fall in savings and rise in consumer spending is part of the normal development process. Others believe that the rapid decrease in household savings is abnormal and worrisome. Koreans continue to make buying decisions based on perceived social status, and social pressures result in more consumers spending on unnecessary goods they cannot afford. Hope is not yet lost, a recent article from Korea Times shows that the growth in credit card spending has pulled back in the first six months of this year. Also, 20 and 30 year old spenders are buying more household items as opposed to luxury goods. These are goods signs, but if Koreans do not stop living beyond their income it is almost certainly assured that Korea will face the challenges of other high debt nations.

Clare Hubbard is a former Fulbright Korea English Teaching Assistant and current intern for the Korea Economic Institute.

Photo from Famihish’s photostream on flickr Creative Commons.