The Peninsula

Why Brexit Demonstrates the Need for Structural Reform in South Korea

By Kyle Ferrier

The result of last week’s referendum in the UK to leave the EU was an unwelcomed surprise for global financial markets. Last Friday, the day the final outcome was disclosed, the pound closed 8.4% lower than Thursday’s rate, more than doubling the drop from the previously worst day on record, and the combined loss to investors worldwide amounted to $2 trillion, the largest single day loss ever. The Brexit vote is a major setback for a strengthened European economy and shrouds the already sluggish prospects for global growth with uncertainty. Perhaps more significantly, it also emphasizes the seriousness of the growing backlash against globalization and its influence in politics. As policymakers around the world look to ease the impact of the financial shock from Brexit through further fiscal stimulus and monetary easing, it is vital that they not discount the pivotal role politics plays in managing an economy and how the anti-global integration phenomenon can change the domestic political landscape.

Speaking to elected officials from member states in Brussels earlier this month, prior to the UK referendum, European Central Bank (ECB) President Mario Draghi acknowledged the progress of fiscal and monetary policy had in steering the EU economy, but warned of their limitations without the necessary structural reforms: “There are many understandable political reasons to delay structural reform, but there are few good economic ones. The cost of delay is simply too high.” When speaking about costs, he is referring to economic costs in the form of suboptimal economic growth resulting from political inaction. Yet, what is becoming clearer is that political delays may eventually translate into both economic and political costs in the medium-to-long term. The longer the delay in structural reforms, the greater the disaffectedness with “politics as usual” and the more voters become attracted to isolationism and protectionism.

Facing its own domestic economic issues prior to the UK vote to leave, most of which have been heavily influenced by the global economy, the South Korean government lowered rates and introduced targeted stimulus packages, with plans for additional stimulus to minimize the potential fallout from Europe. Although officials have also advocated for more structural reforms to complement economic measures, the ones most likely to be enacted will have a much narrower impact than the more politically contentious; however, this is insufficient. Political leaders in the Blue House and National Assembly must take action to implement critical structural reforms with widespread economic implications to stem the tide of the populism before the window of opportunity closes. To greater apply this cautionary note to Korea’s context, it is necessary to detail recent developments.

The struggles of Korea’s highly exposed shippers and shipbuilders resulting from prolonged low oil prices and the decline in global trade have prompted government intervention to save the industries earlier this year. Unsustainability of debt amassed by shipping and shipbuilding companies has become increasingly clear as it matures. Bad debt held by banks in Korea is currently at a fifteen-year high. The banks with the highest debt ratios are the Korea Development Bank (6.7) and the Export-Import Bank of Korea (3.35), which are not coincidentally the primary lenders to the three largest shipbuilding companies: Hyundai Heavy Industries, Daewoo Shipbuilding and Marine Engineering, and Samsung Heavy Industries. In Q1 12 percent of loans to domestic shipbuilders went bad and 11.43 percent of loans to shippers went bad. Although the large policy banks are already restructuring debt with a number of companies, more requests are expected in the near future. To ensure the continued solvency of these state-backed banks, the Park administration and the Bank of Korea (BOK) established a 11.5 trillion won fund (around $9.5 billion) to back them, a move praised by the IMF.

Korea’s economic woes in 2016 have not just been limited to the shipping and shipbuilding sectors. In the first quarter GDP grew 0.5 percent, slower than the 0.7 percent posted in the last quarter of 2015. Despite some momentum in private consumption and in the construction sector, inflation fell to 0.8%, well below the BOK’s 2% target. The latest export numbers for May extended Korea’s export slide to 17 straight months, a worrying sign for an economy that is dependent on trade for half of its growth. Looking to boost consumption and exports, as well as making the targeted fiscal stimulus less costly (which is reflected in the official press release as “paying greater attention to financial stability”), the BOK lowered the base interest rate from 1.5% to 1.25% on June 9. On June 14, Finance Minister Yoo Il-hoo stated another fiscal spending package was forthcoming, which has been reiterated by the Ministry of Strategy and Finance and Prime Minister Hwang Kyo-Ahn among others in response to the economic risks posed by the Brexit referendum. The government has stressed a number of structural reforms in areas in the economy to accompany these measures—including in innovation, education, the labor market and finance—yet gaining momentum for policies in some of these key areas has proven quite difficult. This is particularly true for labor market reform, arguably the most consequential economic area and the most politically contentious.

South Korea’s economy has outgrown its labor market regime. The unique dual-labor market system in Korea worsens economic inequality and constrains growth, while also adversely impacting social conditions such as contributing to an increasingly negative outlook on the future. Established through IMF conditionality programs after the 1997 financial crisis, the current labor market regime injected employment flexibility into the conglomerate dominated economy in which employees enjoyed a high degree of job security by designating two types of workers: regular, which are afforded higher wages and protections, and non-regular, which are afforded less of both. One third of working Koreans today who are classified as non-regular receive 64% less per hour worked. They are also faced with essentially non-existent job security and training as their contracts are no longer than two years, providing limited incentives for employers to invest in them. Though initially promising, the push in the last year to improve the labor regime by addressing dual classification system as well as encouraging youth employment and deterring forced retirement was scuttled when a labor union involved in the negotiations defected. Prospects are slim for the issue to be revisited this year due to the political divisiveness on the topic in a divided National Assembly after the April 16 elections, yet the widespread social and economic problems engendered by the current system can only deteriorate if unaddressed.

Korea is far from alone in finding structural reform difficult to pass. Slow progress on structural reforms has plagued international markets since the global financial crisis, resulting in a number of pervasive issues such as low productivity and have hindered even many strong economies, particularly neighboring Japan. While populations around the world seem to be increasingly exasperated with low growth, elected leaders in Korea looking to maintain their country’s reputation as a globally-integrated world leader need to learn from ongoing events in other democratic states and act while the situation at home may still be manageable. Extending an unpopular status quo in the economy due to a political impasse is not only unstainable, it may prove dangerous to the values that have brought the world together since the end of World War II.

Kyle Ferrier is the Director of Academic Affairs and Research at the Korea Economic Institute of America. The views expressed here are the author’s alone.

Photo from Garry Knight’s photostream on flickr Creative Commons.