[VIEWPOINT]Warning: slow growth aheadThere seems to be some consensus among private economic forecasters that Korean economic growth will slow down during the coming year, to a rate somewhere in the 3 to 3.5 percent per annum range.
The Ministry of Finance and Economy disagrees with this and sees higher rates. But, of several economic forecasts I consulted, the most optimistic was that of Deutsche Bank, which forecasts growth of 3.5 percent for 2005. But the Deutsche Bank forecast supposes a pickup in consumer spending in Korea that might not actually take place. If this pickup does not happen, Deutsche Bank warns that Korea’s growth will be less than currently forecast.
For the richest countries of West Europe and North America, or even Japan, 3 to 3.5 percent per annum growth might be satisfactory, but for Korea, it is not. This is because although Korea is now a high-income nation, it has not fully caught up with the richest countries on a per capita income basis and thus a faster rate of growth will be needed in order to close the remaining gap in a reasonable amount of time.
Why is Korea’s growth sputtering then? One important reason might be gleaned from Japan where, following almost four decades of rapid economic growth, the economy has faltered since 1991. Japan thus has experienced either recession or “growth recession” for about 14 years, something that Korea should definitely avoid.
One of the main reasons for slow growth in Japan is “life support” provided by Japanese banks to “zombie” companies. These are firms that are inefficient compared to their world-class rivals and are characterized by some combination of low profitability and high debt, resulting in long-term inability to service the debt.
A recent study shows two startling facts: First, the percentage of all economic activity in Japan accounted for by these zombie firms has actually grown during the past 12 years or so whereas, in a healthy economy, one would expect the share of zombie firms to decline.
Second, the overall effect has been to create a measurable drag on the Japanese growth performance. It can be concluded that Japan does not have zombie firms because the economy is weak but rather the economy remains weak because there are too many zombie firms in Japan, ones that continue to receive support from Japanese banks.
Can the same be said of Korea? Alas, the answer is probably “yes.” During and since the financial crisis of 1997-98, hundreds of Korean firms fell into technical bankruptcy, and many of these firms remain in existence today, even though they have not resolved the difficulties that put them into trouble in the first place.
According to the Organization for Economic Cooperation and Development’s most recent economic survey of Korea, more than 25 percent of Korea’s manufacturing firms have interest coverage ratios of less than one, meaning that they cannot even fully pay the interest due on debt. This is an improvement since 1999, but still, the debt of these firms is something like 16 percent of GDP, too high a figure and one that could increase if growth indeed does slow down. In some cases, the problem remains one of overstaffing; Korean firms, even ones in difficulty, have not been able to lay off excess workers due to Korea’s labor markets remaining rigid.
To date, the government’s policy seems to be to rely on growth eventually to resolve these problems. Indeed, if the overall sustained rate of growth in Korea were to remain as high as it was in 1999 or even 2002, the impact of these problems would diminish with time.
The problem is, as the Japanese experience shows, this is unlikely to happen if zombie firms account for any significant amount of GDP. Rather, over the long term, to resolve the problem of slow growth, the zombie firm problem must first be resolved because, unresolved, zombie firms impede growth.
So what is to be done? One priority remains to create greater labor market flexibility in Korea. To achieve this has been difficult, as policymakers in Korea know well, because of fears of unemployment. But greater labor market flexibility, even if it were to create somewhat higher unemployment now, might be nonetheless necessary to create ample employment in the future at high-income wages.
Beyond this, Korea simply must take the remaining steps necessary to resolve corporate failure, so that the “zombie firm” problem recedes rather than grow further, as it did in Japan. Koreans seek to be at the highest level of the world’s high-income countries. But then the “bottom-line” for Korea is: Don’t let the zombies drag the economy down.
* The writer is a senior fellow at the Institute for International Economics in Washington, D.C.
by Edward M. Graham