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South Korea could be model for Japan’s economic development

20 Comments
By Stephen Heckman

In a sense, South Korea and Japan’s economies are two sides of the same coin. Both are mainly export-oriented economies. Both have had to struggle with an economic crisis – Japan had to deal with the lost decade and Korea the IMF crisis. And both economies have been characterized by large family-owned mega businesses with strong political and banking ties, with the “chaebol” in Korea and the “keiretsu” in Japan. The similar nature of these two countries’ economic cultures makes them ideal for comparative analysis.

However, despite their similarities, Korea and Japan’s economies have taken different paths. Korea’s public debt is 23% of its GDP, while Japan’s public debt is estimated to be at 200% of its GDP, the second highest in the world after Zimbabwe. And while Korea’s GDP growth is slightly positive at 0.2%, Japan’s GDP growth rate is -5.2%, which means Japan’s debt is still increasing.

Perhaps, then, there is something Japan can learn from its neighbor’s economic development. Considering the similarities of these two countries, what could Japan do to imitate Korea’s fast-paced growth? One might be easily led to believe that Japan ought to follow its neighbor’s course by raising the consumption (sales) tax. Prime Minister Naoto Kan has recently called for a national debate to gradually increase Japan’s consumption tax of 5% to 10%, which is the same rate as Korea’s VAT. After all, one could argue, Japan’s consumption tax is already the lowest in the OECD, and the last time the tax increased was in 1997.

However, Japan’s consumption tax is only a small part of the picture. Both Japan’s corporate tax and income tax are significantly higher than South Korea’s, with some individuals paying up to 50% of their salary in income tax. Overall, Japan’s taxes are significantly higher for its citizens and businesses than Korea’s taxes.

In fact, Japan ought to be lowering taxes right now to encourage more spending instead of attempting to lower the deficit. Unlike many other countries’ debts, 95% of Japan’s debt is owed to its own citizens and not to other countries, which means there is minimal time pressure for Japan to pay the debt off and lower its deficit. Also, Japan is borrowing at a low interest rate – the government can currently borrow from Japanese investors for 30 years at a mere 2% interest rate – which is another reason that paying off the public debt should not be the government’s first priority.

The government’s first priority should be to stimulate its economy, not to pay off its public debt. Prime Minister Kan could stimulate growth by lowering taxes to encourage consumer spending, which could reverse the deflationary spiral that created the debt in the first place.

And if the government insists on pursuing its agenda to reduce the national deficit, there are ways around increasing taxes, which would only cause more hoarding of the yen and greater deflation. For example, the government could use the current tax income more efficiently and eliminate unnecessary public projects. In South Korea, cuts in public spending and lowering of government subsidies were key elements to its recovery and current fast-paced growth.

Another example in which the government could use its tax income more efficiently is by allowing more corporate bankruptcy and not viewing the "keiretsu" as “too big to fail.” Korea has discontinued propping up many of its “zombie firms,” or unproductive companies that drain public funding, and allowed many chaebol companies to collapse, including what was once Korea’s second biggest conglomerate, Daewoo.

South Korea could be a role model for Japan’s recovery, and if the prime minister remains in office long enough to enact his plans, let’s hope he observes history and uses a precedent such as South Korea before changing the course – for better or for worse – of Japan’s economy.

Stephen Heckman, MBA, teaches at Hanyang University in Seoul.

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"Both are mainly export-oriented economies..."

A glaring omission here is that much like China, South Korea has routinely intervened on the Won's behalf. Japan has done one large intervention and was roundly criticized.

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"Both are mainly export-oriented economies."

It really is time to retire the idea that Japan has an "export-oriented" economy, with the implication being that it is export-dependent. It's not, as a quick look at any comparative chart showing exports as a percentage of GDP will show.

The author also conveniently ignores that fact that in order for Japan to follow the Korean "model" of economic recovery, the Japanese economy would have to crash, Tokyo would have to accept an IMF bailout, Japan Inc. would have to be dismantled according to IMF demands, foreign "vultures" would have to be allowed to swoop in unimpeded (such as when GM took over Daewoo in Korea), and the Japanese would have to adjust themselves to levels of social dislocation not seen since the early postwar era, with the suicide rate reaching even higher levels than now.

Finally, Japan's hierarchically minded political and economic leaders would have to jettison more than 150 years of modern history (not to mention centuries of premodern history) and start looking "up" to Korea rather than looking down on it. Could happen but unlikely.

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The Korean gov't is funneling billions of dollars to Korean businesses as sketchy "long term loans". The Korean prime minister is also going to foreign markets promising financial backing and smooth transactions. Korea is just copying what China is doing. Basically, giving gov't money to local businesses in order to gain a competitive edge in the global spectrum.

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And both economies have been characterized by large family-owned mega businesses with strong political and banking ties, with the “chaebol” in Korea and the “keiretsu” in Japan. The similar nature of these two countries’ economic cultures makes them ideal for comparative analysis.

Zaibatsu were Japanese family owned mega-corps (Mitsubishi .etc.). They got were broken up after WWII. Keiretsu is an ambiguous word referring to vertically and horizontally linked groups of companies. Most horizontally linked Keiretsu were formed by the remnants of the old zaibatsu forming partnerships. They're not family owned and aren't even actual corporations (They're corporate partnerships) and have been decreasing in relevance. Vertical keiretsu refers to the habit of some large Japanese manufacturers of splitting their production processes into wholly owned subsidiaries.

And while Korea’s GDP growth is slightly positive at 0.2%, Japan’s GDP growth rate is -5.2%, which means Japan’s debt is still increasing.

Government debt doesn't depend on GDP growth. The economy can be growing and government debt increasing (America and many other countries) or shrinking. It depends on whether the government is willing to keep expenditures low so they can pay down the debt. For the record a quick look at wikipedia shows a government deficit in Korea despite solid economic growth in 2009, meaning that Korean government debt actually increased, contrary to the implications of your statement.

The government’s first priority should be to stimulate its economy, not to pay off its public debt. Prime Minister Kan could stimulate growth by lowering taxes to encourage consumer spending, which could reverse the deflationary spiral that created the debt in the first place.

The government has been doing that for 20 odd years. That's why they ended up with this huge debt in the first place! While stimulating the economy would be nice they also need to consider the risk of a loss of confidence in government bonds.

Finally for the record, Korea has a lower birthrate than Japan. Once the current generation starts retiring, things will be looking a lot less rosy for them. The pain Japan is going through now is coming soon for Korea.

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The Korean prime minister is also going to foreign markets promising financial backing and smooth transactions.

Fail miserably, why don't you accuse other leaders who help their contractors to win bid to build reactors in other countries (it's called business diplomacy)?

Korea is just copying what China is doing. Basically, giving gov't money to local businesses in order to gain a competitive edge in the global spectrum.

Another fail, if anything qina is copying and benchmarking everything Korea is doing (eg. shipbuilding, car industry etc.). And what country doesn't give incentives to its own businesses?

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moshiso7: There are limits, degrees of, and differences from country to country regarding government assistance and subsidies for private business. To what degree does Korea differ from Japan? Could be substantial or could be inconsequential. I'm sure volumes can be written about this.

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The economic analysis seems irrelevant. If this comparison can be made, the ROK can be compared w/ the US or the PRC. Scale is different.

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During the Asian financial Cris, korea Won has lost the value like falling leaves. For repaying the foreign debt, Government desperately needed for US dollar ( which was a strong and stable reserve currency) and gold.

Many Koreans living abroad sent their US dollars to the Korea voluntarily. Koreans who live in Korea donated their gold bar, coins and antique as patriotic duties. After a few years Korea repaid the emergency loan to IMF.

Later on they restructured their financial institutions with prudent monetary policy and regulation. They still have debt. However it is under control.It was a remarkable performance.

For Japan sovereign debt, Japanese do not need to sacrifice like Koreans. Government owed the debt to citizens. Not to foreigners! Reducing the debt level is top priority for economy too. Strategy is badly needed for current government.

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To Athletes,

We were caught off guard when the Asian Financial Crisis started, but dab nab it, we were ready in Malaysia. I think that helped ROK somewhat.

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First of all, this article is not reliable at all, especially if we take the "variables" into consideration... and as many comments say, both economies are totally different (not to name that Japan's if considerably stronger and reliable). The WON is being and will be manipulated. There is manipulation of media (the articles on news papers are basically manipulated to brainwash people (worse than other Asian countries) And the extreme nationalism make people pretend Japanese around the world to damage the Japan's reputation: Unfortunately, many of the "ears" listen what those guys say and they 'forget' Japanese products to buy what 'misleading ads' say 'Korean products are that good as Japanese', which is totally wrong...

There are several things to take into account and this articles makes people feel bad without any proper reason.

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The fact most Japanese debt is owned by the locals is only a temporary relief. Japanese population is aging very fast, and the savings owned by old people are used for their old days. Younger generations are not saving in the same proportion (savings rate per household is on a rapid downward trend), which means it will be more and more difficult for the Japanese government to sell debt at reasonable rates.

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Japan’s public debt is estimated to be at 200% of its GDP, the second highest in the world after Zimbabwe.

It is only a matter of time before the economy/currency here crashes in a massive way. Anyone living in Japan - local or Gaijin - who keeps significant currency assets in Japan, has rocks in their head...

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@Jeeeeb:

Government debt doesn't depend on GDP growth.

Government debt doesn't depend solely on GDP growth, but GDP growth IS a major factor, which you conveniently dismiss.

The economy can be growing and government debt increasing (America and many other countries) or shrinking.

The economy can be growing with debt increasing ONLY if growth rate is greater than the debt rate, which as we know in Japan is not the case. As the author points out, Japan has a 200% debt to GDP ratio which means growth must be greater than 200% of its current rate just to break even - not likely in the near future.

It depends on whether the government is willing to keep expenditures low so they can pay down the debt.

Keeping expenditures low is effective for debt reduction (supply side), but also requiring less taxes is necessary for growth stimulation (demand side) - BOTH factors are essential.

For the record a quick look at wikipedia shows a government deficit in Korea despite solid economic growth in 2009, meaning that Korean government debt actually increased, contrary to the implications of your statement.

I didn't look up wikipedia, but again, Korea's growth rate would have had to increase faster than its debt rate, all things being equal.

This is why Japan should not raise taxes, as the author said - taxes lower the debt rate, but at the expense of the growth rate. In accounting terms, you would be increasing assets while increasing liabilities - pushing on a string.

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The writer failed to mention that South Korea did not "allow" chaebol to fail, they were forced into that position by the IMF. Daewoo was literally broken up by IMF requirements. South Korea also does allow its chaebol special rights and privileges. If you are an executive, you get to steal from the company, get caught and then be released and forgiven by the government.

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It is only a matter of time before the economy/currency here crashes in a massive way. Anyone living in Japan - local or Gaijin - who keeps significant currency assets in Japan, has rocks in their head...

If this happens, it won't really matter where we are as there will be a massive global depression unlike anything ever seen before. God help us all.

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@BurakuminDes Your lag about economy and reality is worse than the South Korean example...

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@Koko1

Government debt doesn't depend solely on GDP growth, but GDP growth IS a major factor, which you conveniently dismiss.

No I don't. The statement "Government debt doesn't depend on GDP growth" said in response to the statement "Japan’s GDP growth rate is -5.2%, which means Japan’s debt is still increasing." is quite correct. Japan's GDP growth rate being -5.2% doesn't =mean= the debt is increasing. Drawing such an inference is completely incorrect. That said it is almost certainly a contributing factor.

know in Japan is not the case. As the author points out, Japan has a 200% debt to GDP ratio which means growth must be greater than 200% of its current rate just to break even - not likely in the near future.

Japan doesn't have a "debt rate" of 200%. Its =total debt= is around 200% of GDP. Now I believe what you're referring to is the idea that if the rate of growth of the debt is less than the GDP growth rate then year by year the debt will decrease as a percentage of GDP and therefore be sustainable. This would require the government to decrease the deficit.

I didn't look up wikipedia, but again, Korea's growth rate would have had to increase faster than its debt rate, all things being equal.

This is just plain wrong. There's no rule that says the debt growth rate has to be less than the GDP growth rate. In fact the exact opposite happens all the time.

Now whether this is sustainable or not is a different question. The sustainability of debt depends on the governments ability to refinance it on a yearly basis. This depends on the size of the debt relative to the size of the budget which depends on GDP and tax rates, bond rates (yields),and the structure of the bonds already held. For example if the government has most of its debt held in 30 year bonds, even if bond rates hit a temporary high they'll have much less debt to refinance and so could theoretically wait for bond rates to drop.

As a generalization of this there is a theory that if the debt grows at less than GDP grows at in the long term then it is sustainable.

Keeping expenditures low is effective for debt reduction (supply side), but also requiring less taxes is necessary for growth stimulation (demand side) - BOTH factors are essential.

This is why Japan should not raise taxes, as the author said - taxes lower the debt rate, but at the expense of the growth rate.

More of this lower taxes and economic growth will magically go up stuff. It's possible, but it's also possible for the exact opposite to be true. The US went through a golden-age of solid economic growth, real income growth and low government debts in a time when taxes where much higher than they are now.

In accounting terms, you would be increasing assets while increasing liabilities - pushing on a string.

This is also just plain wrong. A Liability in accounting terms is something you have to pay. Even assuming it did lower the growth rate that wouldn't create any liabilities.

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@gregoms Nice to see coherent people around here; these Anti-North Korean and Anti-Japan people have to stop writing no sense to make everybody feel down. A fact of what you wrote is 'hyundai' and its CEOs. And we have to note that there is NOT a single South Korea's president not involved in corruption since its first president. Why using South Korea as example when that country is just the example of 'questionable' and mediocre performance. The appearance betrays.

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Japan needs to remove all the taxes related to motor vehicles so as to stimulate new vehicle sales. When the consumption tax was implemented, they still hung on to all sorts of sales taxes. The basic idea of a VAT or consumption tax is to tax goods at point of sale and other taxes should be removed. New Zealand has a reasonable GST system, although at a higher rate, it is regarded as a fairer tax system. Sales taxes were removed apart from Tobacco and petrol. I fear that if Japanese consumption tax was raised, the government would still try to hang on to the many other taxes. Eg. vehicle weight tax, CC rating tax and others etc.

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Look at the Japan-defenders running in to deny Japan could possibly learn anything from Korea! To them admitting that would be a fate worse than drowning in manure, LOL

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