"Nurturing SMEs & Fostering a Welfare State: How Much Can Korea Afford?"

By Aaron McKenzie, research fellow at the Center for Free Enterprise in Seoul

If the election of Park Won-soon as Seoul's mayor last October is any indication, the upcoming April parliamentary elections will turn on matters of social welfare and inequality. More importantly, however, these elections will be a sign of the degree to which Koreans are willing to accept the vagaries of a market economy which, while leading to unequal outcomes of wealth accumulation, is a precondition for a sustainable welfare state. Discussion of such matters could scarcely come at a more pivotal time for Korea, facing as it does an aging and declining population, a slowing economic growth rate, and reinvigorated concerns about reunification with North Korea. Unfortunately, Korea's political class shows little sign that it understands the gravity of the moment, competing not in a battle of ideas over how to revive the economy but rather to see who can most flamboyantly give away other people's money.

Park Won-soon, of course, rode into office by pledging to increase social welfare spending and to improve the "fairness" of the capital city's culture. As his first order of business as mayor, Park signed a bill extending "free" school lunches to all Seoul elementary school students regardless of family income, a program which he has vowed to expand in 2012 to include middle school students. Sensing this direction in the political winds, the ostensibly conservative Grand National Party, led by President Lee Myung-bak, has put forth its own set of welfare proposals, ranging from state-funded childcare to subsidies for university tuition. That these are as much middle class handouts as they are social safety nets for the poor is especially troubling given the looming demographic and economic challenges facing Korea in the coming years.

In 2008, according to the OECD, South Korea had 6.3 workers for every non-worker (that is, a person under 14 and above 65 years of age). By 2050, this number will fall to 1.5. Clearly, this signals that a progressively greater burden will be placed on the working population to support the older members of society. Thus, even if Korea's current slate of social welfare programs were frozen in its present state, simply meeting the needs of a growing class of retirees would require an ever-higher rate of economic growth.

Moreover, the recent death of Kim Jong-il, and the ascension of his son, Kim Jong-Un, to the throne has created that most dicey of situations in a totalitarian state: a leadership transition. The sixty-plus year division of the two Koreas has caused many to treat reunification as a mere abstraction, but the costs, which could come at any time, will be all too real. Indeed, estimates begin at US$1 trillion and scoot upward from there. Yet, while South Korea is committed to taking in its northern cousins, no concrete plan has yet been put in place to pay for the world's most expensive family reunion.

As if these challenges were not enough, the nation's economy has begun to sputter just when South Korea needs increasingly robust economic growth. South Korea's growth rate, so impressive for so many years, has recently begun to look rather pedestrian, growing at 3.6% in 2011 (BOK) and expected to grow at 3.8% in 2012 (OECD). To be sure, the global economic woes have been a blow, but many economists are beginning to speculate that Korea's export-led manufacturing model may be losing steam and thus incapable of carrying the country into its next generation of development as an advanced economy.

At the same time, the nation's public debt has been ticking steadily upward for several years now, reaching 33% of GDP in 2010 – a number which does not even include the liabilities of heavily-indebted state-owned enterprises, which push the figure to over 60% of GDP. The thought of adding the weight of further entitlements to the government's budget, even as current and future promises will be challenging to meet given expected growth trends, should thus be cause for concern.

As Korea's slowing growth rate shows, the country is failing to maintain its past sense of economic vibrancy. To revitalize the nation's economy for the 21st century – a necessary step if the economy is to throw off the revenues necessary to support increased welfare spending – the government must loosen its grip on the economy and especially on the nation's small-scale entrepreneurs, whom it claims are among those most in need of market protection and welfare assistance. To date, the Korean government has sought to help small- and medium-sized enterprises (SMEs) and start-ups chiefly by coddling them – for example, by giving them underpriced loans or by declaring certain business sectors (such as tofu, ready-mix concrete, and LED lighting) off-limits to the chaebol. Not only do such measures restrict consumer choice and saddle taxpayers with extra debt from non-performing loans, they do nothing to promote the long-term viability of these companies, which never learn to compete on their own.

While its recent devotion to new free trade agreements is laudable, the government must go further in freeing the Korean economy. Rather than cosseting SMEs, then, the government should remove restrictions which hamstring would-be entrepreneurs. To take just one example, regulations currently state that beer companies wishing to sell their brew on store shelves must be able to produce at least 3.8 million bottles per year, a rule which effectively quashes the ambitions of any aspiring microbrewer. This not only prevents the creation of new jobs (especially for woefully underemployed twentysomethings in Korea) and better quality products, but also serves to further reinforce the gaps between big companies and small, and between rich and poor, which so anger the electorate. Before it sets to enacting further subsidies and welfare programs, the Korean government should thus adopt a "first do no harm" policy by clearing its books of this and similar regulations which act as a barrier to initiative and ingenuity.

The first lesson of economics is scarcity, the fact that we live in a world of limited resources which we use in pursuit of our unlimited desires. Regardless of how much we might like to expand existing welfare programs, or how many new entitlements we might desire, the current question on voter's tongues, therefore, should be "how much can Korea afford?" Wealth must be created before it can be redistributed, and given the inflection point at which Korea now finds itself, the nation's voters and politicians should be seeking new ways to create rather than simply transfer. Before creating a raft of new programs which encourage dependency and restrain ambition, the Korean government should allow citizens to create their own prosperity.

This article was originally published on Korea Business Central on January 29, 2012 and Korea Herald on February 8, 2012.