April 2013 (McKinsey Global Institute) – Beginning in the 1960s, South Korea has set economic-development records with a growth formula that focused on heavy-industry and manufactured exports. GDP has tripled in just the past 20 years, and South Korea became the first nation to go from being a recipient of aid from the Organisation for Economic Co-operation and Development to being a member of its donor committee. South Korea is the leading supplier of LCD screens, memory chips, and mobile phones and is the world’s number-five automaker.
Yet the nation’s GDP growth is increasingly decoupled from the lives of its middle- income citizens. The number of middle-income households—earning 50 to 150 percent of median income—has fallen from 75.4 percent of the population to 67.5 percent since 1990, and more than half of middle-income households are cashflow constrained when the full costs of housing payments are counted. The squeeze contributes to trends that could affect future growth, including a plummeting personal-saving rate and one of the world’s lowest fertility rates. Beyond Korean style: Shaping a new growth formula, a new report from the McKinsey Global Institute (MGI), explores the causes of these economic challenges and makes specific recommendations for combatting them. Among the report’s findings:
- South Korea’s largest industrial corporations have continued to grow rapidly, but mostly in new global markets; their domestic employment has fallen by 2 percent annually for 15 years, leaving job creation to small and medium-sized enterprises (SMEs) and Korea’s underdeveloped service sector, where wages are just 55 percent of manufacturing pay.
- Spending on housing and education have soared (exhibit). The median price for a home in South Korea is 7.7 times the median annual income—more than twice the US multiple. South Koreans also pay much more to finance their home purchases because low loan-to-value limits often force homebuyers to seek supplemental, high-interest loans. Spending on private education is extremely high as well (around 9 percent of GDP) because South Koreans believe admission to a top university is the only path to success for their children.
Exhibit
But South Korea can take specific steps to strengthen its middle-income households, increase domestic demand, and build a more balanced economy. Namely:
- Reduce housing payments. By switching to mortgages with looser loan-to-value limits, MGI estimates that South Korean homeowners could save $8 billion annually in payments. South Korea can also encourage more investment in rental housing and can consider shared ownership programs.
- End the education “arms race.” Even though Koreans continue to sacrifice to prepare their children for university, unemployment rates are higher for South Korean college graduates than for graduates of vocational high schools. And when costs are factored in, the net present value of the lifetime earnings of a privately educated college graduate is lower than those for a graduate of vocational high school. To help parents consider alternatives to a university education, MGI suggests higher investment in vocational education and expansion of the Meister school program, in which employers collaborate with schools to create job-relevant curricula. A dual-track system would enable students to continue on to college degrees as they progress in their careers.
- Build up services and SMEs. South Korean services are dominated by low value-added enterprises, particularly local services (for example, restaurants, real-estate sales, transportation). South Korea can build on the success of sectors that are already globally competitive, such as construction engineering, and help expand sectors such as health care, tourism, and financial services.
- Create an entrepreneurial SME sector. Most SMEs are very small, and few mid-sized enterprises become large companies. Structural problems are partly to blame, but South Korea also lacks an entrepreneurial tradition and offers limited support for innovative risk-takers. South Korea can work to expand access to capital, increase intellectual-property protections, teach entrepreneurism, and update bankruptcy regulations. These initiatives will take a concerted effort by policy makers, business leaders, and South Korean citizens. But the result could be a new growth formula that complements the current model, reverses the erosion of middle-income households, and builds a sustainable future for all South Koreans.
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