Moon’s mission of relief to disillusioned youth
Pump priming won’t do it as reforms are badly needed
SOUTH Korea has a new President, Moon Jae-in, who was voted in on May 9 following the impeachment of Park Geun-hye in December last year (first elected President in 2012).
Expectations are high for him to make good the promised reforms to root out corruption, create jobs and bring about a fairer society. After decades of impressive economic progress, South Korea’s growth has slowed since 2012 and remained rather sluggish of late. The economy faces a number of strong headwinds, including rapid population aging, heavy reliance on exports, rising corporate vulnerabilities, labour market distortions and lagging productivity. Hence, the urgent need for structural reforms.
I visited Seoul early this month. It didn’t take me long to feel the public sense of disillusion that brought about the fall of Park.
True, in five decades, GDP per person has risen 20-fold to nearly US$40,000 (in purchasing power-parity terms, i.e. adjusted for the local cost of living). In one generation, the nation came from being a beggar to become a donor. Yet, its politics has forged ahead of social change.
Youth disillusioned
Networking with university professors and students brought home early the feeling that massive protests were ignited by much more than bringing the imperial-president Park to book. I was told the sense of injustice has been simmering for years. Like the disgruntled in US, UK and France, voters now want the political system to work for them.
Growth is faltering; unemployment is surging especially among the young. Even those with jobs feel the masses live by a much harsher set of rules than the elite. Young Koreans are ever so anxious. Unemployed graduates exceed 3.5 million, out of a total of 14 million.
Life for teens and 20-somethings is stressful, with long working hours and low pay. Surveys show that eight young Koreans in 10 are dissatisfied with the direction the nation is heading. Indeed, youths are more pessimistic about their future income prospects than their parents. I am told that young Koreans now belong to the “Sampo” (or 3-renunciations) generation since they have no time, no resources (for dating) and no prospects (for marriage or children).
Others talk of “O-po” (5-renunciations, adding housing and skill building). Still others refer to even “Chil-po” (or 7, including hobbies and hope). The young complain that they have to give up increasingly more just to earn a meagre living. Worse, the disillusion is compounded by the reality that wealth and connections can by-pass the stressful rat-race.
A recent survey of 44 nations pointed to South Korea as the only place where knowing the right people is the most commonly cited path to success. Hence, President Moon was elected on the platform of regime change, after more than a decade of conservative rule, including rooting out elite corruption.
Pump priming
Moon’s first proposal was to seek a supplementary budget to create public sector jobs. The intention is to prime the pump in the hope the trickle-down effects will bring new jobs. This is an old Keynesian tool akin to employing someone to dig a hole and another to fill it back. The idea is like getting a dysfunctional water pump working again by priming it (i.e. have water flushed back into it to raise the pressure for the pumping to restart).
The Korean economy is not performing – it now faces (according to IMF) structural constraints requiring real reform policies for long-term growth and inclusion. GDP growth had fallen to about 2.5% each in 2015 and 2016 (3.3% in 2014) and remains sluggish for 2017, with inflation remaining subdued. Lagging productivity, an inadequate social safety net, high household debt, and inequality and poverty remain key areas of concern. Still, it has considerable fiscal space – hence, the stimulus package.
As I see it, fiscal stimulus won’t solve South Korea’s secular stagnation. A carefully targeted expansion of social spending can help address inequality, while bolstering the income of the poor. Massive pump-priming has had limited effects in the past. Between 2014 and 2016, government spent 4.3 trillion won (close to US$4bil) annually in an attempt to create jobs.
But the jobless rose to 1.01 million in 2016 from 807,000 in 2013. Unemployment among the young (aged 25-29) rose to 9.2% from 7.1%. The National Budget Office had concluded that a 1 trillion won rise in new budget spending added at best only 800 billion won to GDP in 2014 and 650 billion won in 2015 and 2016. This is classic capitalism without market discipline.
The Japanese experience is not dissimilar. It pumped in 100 trillion yen (US$900bil) over the past 20 years, supported by negative interest rates, a weak yen and tax incentives. It didn’t work simply because the underlying structural weak- nesses were not fixed. Japan’s growth today remains sluggish. Similarly, the massive fiscal spending in the first 100 days of President Kim Young-sam in early 1993 didn’t work either. South Korea needs to tackle serious reforms to avoid moving towards becoming another Greece.
Governance reform
Outdated corporate governance is getting in the way of more rapid growth in South Korea. Much of this is reflected in the collusive ties among businessmen and bureaucrats and politicians, unfair business transactions and practices, and sub-optimal allocation of corporate resources to keep the controlling chaebol families in charge despite their small stake-holdings in the groups they control. More than 95% of listed firms in South Korea are controlled by families including the chaebols, as against 75% in Hong Kong, 70% in European countries and 10% in the United Kingdom.
Of course, rules and guidelines have been put in place for investors to exercise their voting rights, including helping to maintain checks and balances between companies and investors, and to ensure efficient management of corporate capital. Still, the system remains badly managed and poorly implemented, including: inadequate penalties for non-compliance and managerial misconduct; circuitous ownership structure; substantial private benefits through related party transactions (RPTs), multiple compensation packages from affiliated companies, and appointment of family members of questionable quality as senior executives; penalties levied at corporate level only; reluctance of highly-paid family members to be executive directors; poor awareness of investors on shareholder rights (most AGMs take only 30 minutes; also, director elections are often bundled unfairly under one item). These shortcomings have persisted because of the self-serving practices of chaebols.
The independent Asian Shadow Financial Regulatory Committee (on which I am a long-standing member) met in Seoul on July 6 to review “Corporate Governance, Regulation and the Impact of Chaebols on the International Competitiveness of the Korean Economy.”
The committee acknowledged that chaebols (Korean family-controlled conglomerates) were instrumental in South Korea’s rapid industrialisation and economic growth in the post-war era. However, their activities have since become a constraint mainly because of the impact of their circular and interlocking ownership structure and non-transparent activities.
As a result, Korean corporates have under-performed, as reflected in the comparative P/Es of ten major economies including the US, Japan, China and Hong Kong, where it was the lowest in each of the years from 2011 to 2017. The committee welcomed the initiatives taken to bring on a new coordinated corporate governance system consisting of new legislation, corporate governance acts for financial companies, proposed revision of the Commercial Act for all listed companies, and launching the new Stewardship Code.
To improve and ensure their effectiveness in practice, Korean companies will really need to take a number of actions, including: (1) conduct an independent third-party evaluation of board performance; (2) incorporate a policy on board diversity, including representation to reflect its geographical footprint; (3) develop a continuing dialogue between investors (including foreign investors) and independent non-executive directors; (4) separate chairman and CEO positions with the chairman as independent and non-executive. Where the chairman is executive, appoint a strong lead independent non-executive director; (5) institute a compulsory “comply or explain” rule; (6) require the audit, nomination and remuneration committees to comprise (where possible) wholly of independent non-executive directors; or at least, with the majority of non-executive directors being independent; (7) regular and timely disclosures and transparency on all corporate matters consistent with global best-practices, in particular much greater transparency and disclosures of RPTs and MandAs, share buy-backs, dividend policy, and individual director and senior management remuneration; and (8) effective regulations to mandate the cancellation of treasury shares after buy-backs, to avoid risk of conflict of interest and dilution of minority shareholdings.
It is increasingly clear that much more needs to be done in practice to improve corporate governance standards. Korean firms, especially the chaebols, need to step up their dialogue with regulators, institutional investors, and a better organised minority shareholders. The committee concluded that a market-based corporate governance system can function best to promote a more innovative and competitive Korean economy. This simply means that the authorities need to ensure that the supervisory and administrative machinery can effectively implement laws and regulations that are transparent and disclosure-based, rather than merit-based which relies too much on the value judgement of bureaucrats.
What then, are we to do
Despite development and democratisation, South Korea’s youth are restless and pushing for a new narrative: they feel no one really cares about their future, reflecting the public sense of disillusion. The trust of the young in the state’s ability to protect them has been deeply eroded; their elected representatives are a let-down – their actions don’t really reflect their concerns. They talk of the National Assembly as being “vegetative”.
Although its breakneck industrialisation story is an inspiration to many emerging nations, what has happened since to South Korea offers valuable lessons: the higher the rise, the harder the fall. The reality is simply this: urgent need to maintain public confidence – the vague psychological concept which offers a tidy way to describe why things happen when the underlying drivers are uncertain, even though confidence is only loosely connected with growth.
It will take more than just “feelings” to fix the sluggishness of growth and high youth unemployment that has become evident also in Japan, Europe and Asean. In practice, businesses will hire and invest only when they see clear evidence of rising demand; and consumers will commit to spending only when their incomes can support it.
We need to look at the “hard” data around economic activity, not just “soft” data provided by surveys or by the politicians: “That’s what the people want.”
In the end, confidence will reflect underlying fundamentals – whether consumers see job opportunities readily available, for example, and where businesses can see strong advance orders. In my experience, confidence generally goes up when there is strong income growth or big gains in household wealth. In fact, higher spending usually follow a rise in income and wealth, not just a rise in mere confidence (purely psychological).
The Korea story centres around the hopes of the disenchanted: they want to be confident enough for their institutions to become more responsive in fulfilling their hopes – so, more fundamental change is needed; indeed, long ignored voices must now be heard. Their outrage can only be calmed with serious reforms. Deep down, the youths are right. Their struggles offer valuable lessons for leaders the world over.