Shifting the South Korean economy

By Troy Stangarone

Despite President Moon Jae-in's successes with North Korea, the last two months have been difficult for the Moon administration on the economic front. The OECD recently downgraded expectations for South Korea's GDP growth in 2018.

Perhaps more worrying, job growth has been anemic in recent months. In July only 5,000 new jobs were created and in August job growth fell further with only 3,000 new jobs. Unsurprisingly, these shifts have raised concerns about the impact of the Moon administration's income-led growth strategy.

The issue of income inequality is one that has come to the forefront in South Korea in the last two decades. For much of South Korea's economic development, income inequality was relatively low. In 1990, 75 percent of South Koreans were middle class. That has shifted in recent years, with the middle class falling to 65.7percent of the population in 2016.

Workers in the bottom 10 percent of income brackets have seen virtually no wage growth in two decades, and income inequality continues to increase. Coupled with growing income inequality, South Koreans on average continue to work some of the longest hours of countries in the OECD.

Deployed with a longer adjustment period for businesses, the Moon administration's policies of shortening working hours and raising the minimum wage would have helped to address these two issues, especially for those in the lowest income brackets.

However, they also only address part of the shift the South Korean economy needs to undertake if it is to remain competitive with other developed and developing economies such as China.

Unlike the United States and other developed economies, South Korea's economy is still fairly heavily focused towards the production of manufactured goods. In 2017, 35.9 percent of South Korea's GDP was made up of manufacturing, while services only accounted for 52.8 percent.

In contrast, services accounted for 80 percent of the U.S. economy. Even in other well-known manufacturing economies such as Germany, services account for 70 percent of GDP.

The underdevelopment of the services sector, which accounts for 70 percent of employment in South Korea, impacts wage levels, job growth, and South Korea's overall productivity. While South Koreans working in manufacturing have among the highest compensation levels of OECD countries, the compensation for South Koreans in the services sector is among the lowest in the OECD.

Encouraging the development of a more dynamic and productive services sector would help to address the issue of wage stagnation and income growth. As services firms grow, they would create new job growth and competition for labor that would help to drive up wages.

Developing the services sector is important for the South Korean economy beyond the benefits on income and job growth. South Korea will not always be able to depend on manufacturing to grow its economy. While total exports this year are up, a significant portion of that increase is driven by the growth in demand for semiconductors.

However, it is not merely a need to lessen South Korea's dependence on semiconductors and automobiles that will reshape the future prospects for South Korean manufacturing; increasing competition from developing countries such as China and growing demands by developed countries that more goods be produced domestically, as we are seeing in the United States, will put pressure on South Korea's exports of manufactured goods.

Additionally, if South Korea is unable to build a stronger services sector over the medium-term, South Korean manufacturers will begin to lose competitiveness in export markets. Firms are shifting in two ways, in terms of the software that is integrated into products and the services that are sold through those products.

While Samsung remains the world's largest seller of smartphones, it has not had the success in developing the digital ecosystem to complement its hardware that Apple has with its app store and iTunes.

By bundling services with its hardware, Apple provides both the platform for additional services on iPhones and services of its own, allowing it to create additional revenue streams. Even in the automotive industry, software and services are an increasingly important part of the development of new vehicles.

While an increasing emphasis on enhancing productivity in the services sector and spurring new firms will be important for the South Korean economy and raising wages, it will not be a panacea for all of South Korea's economic challenges.

In fact, it will also likely increase inequality because the range of salaries in the services sector is wider than in manufacturing. But at the moment South Korea lacks many the middle and high paying services jobs found in high-end services in other economies.

A more robust services sector would create new jobs, raise wages, and support the continued success of South Korea's manufacturing sector. While the focus on the job numbers of the last couple of months is understandable, the real focus needs to be on expanding productivity and new opportunities in the services sector.

Troy Stangarone (ts@keia.org) is the senior director of congressional affairs and trade at the Korea Economic Institute.