President Moon's Wage Increases Pose Fiscal Risk to South Korea

While every year has its challenges, 2017 was no ordinary year for South Korea. In the aftermath of former president Park Geun-hye’s impeachment, a presidential election was held in May 2017 — much earlier than originally planned. This election saw the key economic priorities of the former government (deregulation and innovation) give way to a new regime focused on values of fairness and mutual prosperity.

It is true that South Korea has tended to close its eyes to fairness and social values in its striving for economic growth. But fairness is a necessary value for providing the right incentives, social stability and harmony for economic prosperity. The pursuit of social value eases failures in coordination and leads to a better equilibrium for society.

These values are reflected in the slogans "fair economy" and "social economy" that have been promulgated by new President Moon Jae-in’s administration. The new government has focused on income-led growth strategies as well as intensified checks on unfair trade practices and chaebols. But these policies are not without risk.

The key concept that governs the economic reforms of Moon’s administration is income-led growth. This strategy seeks to create a virtuous circle among wage, consumption, investment, productivity and employment by boosting wages and in turn boosting domestic demand. The key driver of income-led growth is increased consumption that is backed by wage growth.

A major focus in implementing Moon’s income-led growth agenda has been increasing the minimum wage. The South Korean government has mandated the minimum wage since 1989 and reviews its appropriateness every year. But this year’s raise reached historic levels — an increase of 16.4 percent from 6,470 won (US$6) to 7,530 won (US$7) an hour. The Moon administration aims to increase the minimum wage further to at least 10,000 won (US$9.20) by 2020.

Though the minimum wage affects only around 10 percent of workers directly, advocates believe that it will have a spillover effect, shifting the overall wage distribution upwards. But with the minimum wage set to soar over the next year, the complaints and fears of small business owners who are directly exposed to minimum wage and near-minimum wage employees are emerging. They argue that it will severely harm their profitability. Classical economic theory predicts that employment will shrink as the minimum wage rises, as those who are relatively less productive will be ousted from the labor market.

Empirical evidence on the effect of the minimum wage rise on employment is mixed. Admittedly, increasing the minimum wage is a relatively easy and cheap policy, as it transfers most of the accompanying costs to companies. But some experts suggest that there are more direct and potentially better measures to address poverty and a skewed income distribution, such as the Earned Income Tax Credit (EITC).

In addition, the government is set to increase spending substantially to expand welfare, to create public jobs and to enhance job security. Examples include widening the coverage of health insurance, significantly increasing public employment — such as firefighters and police — and converting non-regular workers into regular workers in public institutions.

The intentions of the Moon administration are good, but the financial burden they will create is a significant problem. Currently, South Korea is in a healthy economic situation in terms of tax revenue. But South Korea should watch out for expanding national debt. A recent Korea Development Institute study warned that — given the aging population and sluggish growth trends — if the current fiscal spending and economic growth rate continue, the tax burden will rise significantly to meet the growing national debt ratio. Balancing the current boost in welfare and employment against the financial burden on future generations will be a challenge.

Moon has also appointed Kim Sang-jo as the new chairman of the Korea Fair Trade Commission. Kim is pushing hard to eradicate prevalent unfair trade practices, particularly in franchises, agents, distributors and subcontractors. The unbalanced relationship between small and large companies has been pointed out as a chronic problem. Kim, a corporate governance expert, is also strengthening regulations on large business groups. For example, he has established the Business Group Bureau dedicated to chaebol investigation and monitoring internal transactions.

In his inaugural speech, Kim declared that he would wipe away the tears of the "weak." By the "weak," he was referring to small and medium businesses rather than consumers. This seems to offset the Commission’s essential missions — competition advocacy and protection of consumer welfare. For these new initiatives to be fruitful without harming economic efficiency and consumers, sophisticated policy design will be required.

This year was a preparation period for South Korea: it established a roadmap for new economic reforms. But while Moon’s economic reform agenda looks promising, he must be wary of the potential risks. An economic efficiency is not something you should ignore in order to achieve fairness and mutual prosperity. And we will need to take future generations into consideration when discussing fairness and mutual prosperity.

The News Lens has been authorized to republish this article from East Asia Forum. East Asia Forum is a platform for analysis and research on politics, economics, business, law, security, international relations and society relevant to public policy, centered on the Asia Pacific region.

TNL Editor: Morley J Weston