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.© Japan Today