Commentary: Korea's Looming Pension Debacle

By Moon Ihlwan

The South Korean presidential campaign is reaching fever pitch as the Dec. 19 election day draws near. The hot-button issues: North Korea, the economy, and the corruption of President Kim Dae Jung's outgoing regime.

It all makes for lively politics and good sound bites. But there's an issue no politician dares discuss: the country's looming pension debacle. That's too bad, because South Korea's pension dilemma could prove to be the most pernicious in Asia. "For political reasons, the pension system was designed so that trouble wouldn't surface until decades later," says An Chong Bum, a public economics professor at Sungkyunkwan University in Seoul. "Our offspring will face catastrophe unless it is overhauled."

The long-term problem is simple: The benefits are too generous, and the payroll tax too low. When South Korea started the system in 1988, it looked like a real bargain: If workers and their employers each chipped in a sum of just 1.5% of a worker's pay, later rising to 3% and now 4.5%, they would get 70% of their average yearly salary once they turned 60.

To build up the fund, the first retirement checks won't be cut until 2008. But the troubles ahead are already obvious. The plan was first debated in the 1970s, when Korean women had an average of 4.5 children. Now the fertility rate has dropped to 1.4, a product of South Korea's rapid industrialization. As a result, instead of having 10 workers in 2020 supporting each retiree, the system will have just five.

On top of this, the plan was launched when double-digit economic growth was a given. But growth has slowed, and unemployment has crept up, so wages aren't rising so fast and contributions to the pension system aren't meeting expectations. The result: Government planners project the system will start losing money in 2034--and there'll be no pension assets left at all by 2048. And these estimates don't include assimilating North Korea if that impoverished country collapses. "Whether you like it or not, the South will have to absorb the North once it falls apart, and the social-security burden will be colossal," says Kim Chong In, a former presidential economic adviser.

South Korea, of course, is not the only nation in this fix. In Japan, the system's unfunded pension liabilities are more than 100% of gross domestic product; in France and Italy, they top 200%. But Korea's much newer plan, which has never paid out a penny, will face unfunded liabilities totaling 50% of GDP by 2008.

And there's a shorter-term problem embedded in the pension dilemma. Before the system goes broke, its assets will pile up enormously. With money coming in but not going out, the fund has ballooned to $75 billion--equal to one-eighth the capitalization of the country's stock and bond markets. That figure will jump to $206 billion by 2010 and $521 billion by 2030, before it starts declining precipitously.

Why is this an issue? This pot of money is set to dominate Korean finance--and it's by no means clear it is being put to work wisely. The fund is invested entirely in South Korea, largely in government and corporate bonds. "Its dominance in the capital markets is only growing, and it will increasingly sway the direction in the markets," says Shin Sung Hwan, a finance professor at Hongik University in Seoul. The fund is managed by a committee led by the Health & Welfare Minister, and critics say it lacks the expertise to diversify the fund by investing overseas.

No one expects the system to be fixed anytime soon. Back in 1997, a reform commission recommended changes to ward off insolvency, but bureaucrats and lawmakers rejected most of them. They did raise the retirement age from 60 to 65 as of 2033 and lowered the pension payout to 60% of an employee's average salary. But to save the system, experts say, the government must drop benefits to 40% and increase the tax to 12%. To reduce the hothouse effect on local markets, the committee could outsource the fund's management to private firms and have them invest a large chunk abroad. So far, that has yet to happen. South Korea acted quickly to save itself from the 1997-98 financial crisis. Such decisiveness is once again in order.

Moon covers Korean politics and finance from Seoul.

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