The Bank of Korea has no shortage of diplomatic ways to explain yesterday's surprise rate cut, including weak domestic demand, sluggish business investment and anemic exports. But it's worth being clear what this move was really about: Japan.
For weeks, South Korean Finance Minister Choi Kyung Hwan and other politicians have been demanding that the BOK weaken the won so Korean exporters could better compete with their counterparts in Japan. Which was fair enough: Since mid-November 2012, when Tokyo began devaluing its currency, the won has surged 44 percent against the yen. Yesterday, BOK Governor Lee Ju Yeol finally bowed to the pressure, slashing the central bank's repurchase rate a quarter of a percentage point to a record low 1.75 percent.
In some sense, however, South Korea still isn't taking Japan seriously enough. South Korea should be less concerned about its short-term export woes and more concerned about the prospect of mimicking Japan's lost economic decades since the 1990s. Unless policymakers act far more aggressively in the near future, they still risk a long term state of "Japanization," a semi-permanent deflationary funk that strangles living standards. Here are three ways Seoul can avoid that fate.
First, it should end its monetary stinginess. With inflation at the slowest pace since 1999 and exports down 3.4 percent last month, Lee should lower interest rates even further -- immediately. Considering monetary policy shifts can take six months to affect the real economy, South Korea can't afford to wait.
South Korea's high household debt levels -- currently at a record $962 billion, or 70 percent of gross domestic product -- are said to have dissuaded Lee from cutting rates sooner. And he's right not to take that problem lightly. But Seoul can offset the risk that lower rates will exacerbate household debt by introducing so-called macroprudential policies: tighter regulations on future loans; bans on risky, low down-payment mortgages; and even new taxes to deter households from becoming overly indebted in the first place.
Second, South Korea should prod companies to raise wages. Beginning this year, South Korea’s family-owned conglomerates, or chaebol, will be subject to a 10 percent tax on excessive hoarding of cash that could be better spent on wages or investments. But Korea also must address the breakdown of the labor market over the last 15 years. Today, about a third of the workforce is employed on temporary contracts that offer lower pay than full-time employees -- about 56 percent less, on average -- and limited benefits. The Japanese example underscores that this is a serious impediment to economic recovery: part of the reason that the combination of fiscal stimulus and monetary easing initiated by Japanese Prime Minister Shinzo Abe has failed to gain traction is that 38 percent of people in his country are working under similarly precarious conditions.
South Korean President Park Geun Hye could help change this situation by using her bully pulpit to shame companies that underpay workers. She could also push for tax laws that would give those companies financial incentives to hire their part-time staff to full-time contracts. As Employment and Labor Minister Lee Ki Kweon told Bloomberg News recently: “Management at companies should stop this misuse -- hiring temporary workers just for cost-cutting purposes. Profits should also be used to improve conditions at subcontractors, whose workers are paid much less.” He added that “this isn’t just about philanthropic capitalism” -- it's good business practice, as fatter paychecks give workers more disposable income to spend on the things they're helping to produce.
Third, South Korea needs to stop obsessing over exchange rates. The country needs to become more competitive, but it would be a mistake to pursue that goal solely through depreciation. (Japan has discovered over the past two decades that depreciation can't counteract persistent deflation.) The South Korean government should instead be focusing on structural reforms that would give companies more incentive to innovate and raise productivity. (It could change the tax system, for example, to support new startups, rather than the chaebol who are privileged under current arrangements.) In that sense, South Korea should be modeling itself on Germany. As I've written before, German exporters don’t grumble about currency rates when times are tough; with encouragement from their government, they adjust and find new ways to maximize profits.
Park seems to recognize that South Korea must learn to thrive even when exchange rates move against it. She has pledged, for example, to build a creative economy that produces new industries, generates good-paying jobs and reduces the dominance of the chaebol. But for too long, South Korea has relied on depreciation to shield the country from creative destruction.
The BOK's recent rate cut was the right move for now; in the short term, it should help exporters keep pace with their competitors. But if South Korea wants to avoid ending up in Japan's economic rut, its ambitions will have to go beyond interest rates.
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