[ANALYSIS] Korea's economy threatens to go the way of Japan

President Yoon Suk Yeol talks with U.S. President Joe Biden, left, and Japan's Prime Minister Fumio Kishida ahead of a trilateral meeting on the sidelines of the G7 Summit in Hiroshima, Japan, May 21. AP-Yonhap

S. Korean companies, households unlikely to rush to de-leverage: economists

By Kim Yoo-chul

The Japanese economy often receives a bad rap from experts. The usual and common narrative is that Japan suffers from a low economic growth rate, low birthrate, huge government debt, an aging population, average entrepreneurship and dying regions.

When the Japanese economy enjoyed a glorious heyday in the late 1980s due to rapid economic growth, the mainstream view was that Japan might one day become the richest country in Asia. But the meteoric growth achieved during this period was associated with the development of a large-scale asset price bubble in Japan, which kick-started the "lost decades" for that country.

Considering the significant similarities between South Korea and Japan and also their fundamental economic structures ― export- and labor-led growth ― economists and policymakers now say the shrinking South Korean working-age population, weakening exports, growing concerns about global financial fragmentation, faltering industrial output and slowing economic growth will erode real incomes for South Korean households.

Look at the bizarre similarities between the financial risks that emerged in Japan in the late 1980s and those now escalating in South Korea, Asia's fourth-largest economy. Data from the Institute of International Finance (IIF) show that South Korea's total household debt-to-gross domestic product (GDP) ratio was the highest among the 34 major economies in the first quarter of this year. Also, South Korea was the only country whose household debt went over its GDP for the first three months of this year, according to IIF data.

Workers assemble a truck at a Dongfeng Motor manufacturing plant in Shiyan, a city in central China's Hubei Province, May 12. China's factory activity decelerated in May, a survey showed, adding to signs that China's economic rebound after the relaxation of pandemic restrictions is slowing. AP-Yonhap

But it seems unlikely that the South Korean economy will suffer any short-term ripple effects from mismatches between asset values and liabilities. The government's tighter loan-to-value restrictions on mortgage-lending, and higher taxes on owners of multiple houses have had a visible effect in terms of helping the government lower its debt ratio to below 55 percent, the level viewed by economists as manageable, as of last year.

Seo Ji-young, an economics professor at Sangmyung University, said the South Korean economy will not enter into a "balance-sheet recession" because there is less possibility that the economy will see a land-and-stock bubble burst. "Amid continued tighter regulations on mortgages, a growing sign of mild recovery in apartment prices and expectations of the Federal Reserve's moves to wind down its rate-hiking cycle, major South Korean companies and households are unlikely to rush to de-leverage," he added.

Given the still tepid industrial output data, economic policymakers in the country, therefore, are asked to take steps to stimulate domestic demand. Moody's Analytics expect the Bank of Korea (BOK) is unlikely to raise its interest rate "again" this year as it balances the need to support economic growth against inflation concerns.

Because the economy is heavily dependent on exports, China's still-weak demand and the sputtering global economy are hurting the domestic economy. This means the country will have to rely on domestic consumption and investment to accelerate growth. From that perspective, easing inflation and a pause in interest rate hikes will lift consumer sentiment, according to its analysis.

Tokyo, Seoul's investment in tech sectors, China risk

Of note is that Japan was trying to reinvent its economy by concentrating on value-added advanced materials, parts and even components that went into semiconductor and battery supply chains.

The point is that while economic growth remains the core driver both for the Japanese and South Korean economies and for the viability of Tokyo and Seoul's political systems, the similarities are that the two are facing challenges from increased global tensions such as growing North Korean nuclear threats and the ongoing U.S.-China rivalry. This has increased calls for the necessary review of economic growth drivers in regard to factors pertinent to these current situations.

"I would say Japanese semiconductor- and battery-related tech are now anchoring a lot of Asian supply chains and such a trend is being applied to South Korea. There is a new competitive balance between Japan, South Korea and Taiwan in terms of solidifying the resilience of supply chains and developing technologies. Building reliable supply chains is crucial to productivity and the countries' economic growth," a senior government official said.

Flags of the U.S. and China are displayed in this illustration. Reuters-Yonhap

Deepening the Washington-Seoul-Tokyo alliance in tech supply chains will help both South Korea and Japan in terms of boosting trade growth and creating opportunities to improve domestic consumption. Japan said it is planning to provide $1.5 billion in financial incentives to U.S.-based chipmaker Micron Technology to bolster domestic chip production.

But Park Joo-heon, an economics professor at Dongduk Womens University, advised Seoul's top policymakers to come up with plans to improve relations with Beijing. During the first quarter of this year alone, South Korea posted a $7.8 billion trade deficit with China.

"Supply chain cooperation between the U.S. and Japan will help South Korea minimize the economic impact from external risks. However, given South Korean exporters' dependence on China, it's necessary for the government to apply detailed measures to protect industrial ecosystems," he said.

Unlike Japan, labor unrest in South Korea has a global impact as the country serves as a key hub in global supply chains in tech products. Therefore, amid rising interest rates and weakening global demand, strikes are blamed for export declines.

The provision of more tax credits to domestic small- and medium-sized enterprises (SME) and foreign companies is necessary as the country needs to avoid the difficulties that swept Japan back in the late 1980s when its economy lost vibrancy due to its late response in embracing emerging industries.

Citing South Korea's deepening demographic crisis after its birthrate dropped to a record low last year, economists said the country has to deal with declining birthrates in order to avoid catastrophic consequences. This trend in South Korea is also alarming policymakers in Japan. Amid a rapidly aging population, low birthrates are burdening the South Korean and Japanese economies and their pension systems.

The International Monetary Fund (IMF) recently lowered its economic growth outlook for South Korea to 1.5 percent. The BOK's target for the country's economy throughout this year is 1.4 percent.