The Korean economy is like a frog in a pot of slowly boiling water. It is in grave danger but the Korean people do not perceive it.
So warn the analysts of McKinsey & Company who have recently written a report on Korea. Titled “Beyond Korean Style: Shaping a New Growth Formula,” the report urges Korea to retool the economy before it is too late.
Fifteen years ago, the global management consulting firm issued its first report on Korea. At the time, it focused on the excessive debt of large corporations that plunged the nation into an unheard-of economic crisis.
This time, it highlights the financial difficulties of the middle class, a problem that has multiple causes and is therefore difficult to tackle. But it is a problem the nation must address if it wishes to see its economy grow to its full potential.
According to the report, more than half of middle-class households in Korea are saddled with deficits as they spend more than they earn each month. It cites several familiar factors for the surge of these vulnerable “poor middle-class” families.
For starters, it points to the high cost of owning a home. Many middle-income families are groaning under the burden of repaying their mortgages.
Loan repayments weigh heavily on them partly because of the short duration of mortgages. In Korea, mortgage terms are usually 10 years, while in advanced countries, the most common terms are 15 and 30 years.
Another reason is the tight loan-to-value regulation. Under the current rule, a home buyer can only take out mortgages from his bank up to 50 percent of the value of the home he plans to buy; for the remainder of his financing needs, he has to rely on higher-cost loans from non-bank institutions.
The report urges the government to ease the LTV regulation, which was introduced years ago to curb speculation in real estate. There are no signs of a speculative boom at the moment, but the government is opposed to taking risks.
While it would be wise of policymakers to err on the side of caution regarding the LTV rule, they need to find ways to make longer-term mortgages available and, more importantly, increase the supply of low-cost rental homes.
The report also cites parents’ excessive spending on the education of their children as a major cause of the poor financial status of middle-income households. To address this problem, the first thing the government should do is to improve public schools.
At the same time, as the report advises, it needs to upgrade vocational training at the secondary level, which can help students find a job without a college diploma. In this regard, the success of Meister high schools is inspiring.
The government began to set up Meister schools in 2010 to help talented students develop expertise in specific technical fields, such as mechanical engineering and shipbuilding, and get a job after graduation.
The schools have lived up to expectations, initiating a change in people’s perception of education. To ensure that these schools take firm roots, the government needs to solidify cooperation between them and their partner companies in developing curricula and arranging apprenticeships.
Another reason many middle-class families are in dire straits is household income stagnation, which the report says results from the decoupling of economic growth and increases in household income.
In the past, large export-oriented manufacturing companies created jobs and boosted household income in the process of expanding their businesses. But not anymore. They continue to grow, driving the economy forward, but their share in total employment has dropped sharply.
As a result, the nation relies more on small and medium-sized enterprises and the service sector for employment. But these sectors suffer from low productivity, which means they cannot pay high wages. Hence a stagnation in household income.
To boost middle-class income, the report calls for fostering SMEs and venture companies and cultivating such promising service industries as health care, finance and tourism.
McKinsey’s policy recommendations are similar to those offered by domestic research institutes. In fact, bolstering the middle class is one of the central goals of the new government.
Yet the consulting firm highlighted the urgent need for economic reform. To avoid being cooked to death in boiling water, Korea should rush to undertake an economic paradigm shift.