April 17, 2017 12:10 pm JST

South Korea, Taiwan face 'high-income trap'

Whoever leads them needs to shed middle-income mentality

HIROSHI MURAYAMA, Nikkei senior staff writer

Taiwan's economy has grown to a level where it is now a high-income economy.

TOKYO -- In South Korea, a recent series of rallies drew thousands of outraged citizens and led to the impeachment and ouster of President Park Geun-hye. In the upcoming presidential election to fill the vacated post, an opposition candidate is seen as the favorite.

The events reminded me of the occupation of the parliament building by student protesters in Taiwan three years ago. As in South Korea, the public demonstration of protest led to a change in the administration.

South Korea and Taiwan have led similar development paths, and similar things have happened. This is why I worry that they could fall into a "high income trap."

Frustrated young

On the morning of the last day of Park's presidency, a Taiwanese news site ran an article saying that South Korea may face dire economic straits no matter who becomes the next president. The article quoted a professor at South Korea's Yonsei University, who said job creation, especially for the young, should be the top priority for the next administration.

Park's ouster was driven by candle-holding demonstrators who marched in the rallies from late October to December -- many of them young people. South Korea's jobless rate stands at 5.0%, but the figure is 12.3% for ages 15-29. Simmering frustration among the young drove them to demand Park's resignation. That is why creating jobs for young people is the key to appeasing their frustration and achieving political stability in the country, whoever becomes the next president.

Taiwan experienced a similar development. In March 2014, students protesting then-President Ma Ying-jeou occupied the Legislative Yuan, the parliament building, and this triggered a series of events that led to the election of Tsai Ing-wen, an opposition candidate, as president in a 2016 poll. As in South Korea, young Taiwanese face a high jobless rate. The unemployment rate there is now 3.85%, but the figure for those aged 20-24 is 12.57%.

Both South Korea and Taiwan have strong information technology industries. They have also led similar paths in their development. From the 1960s to the 1980s, both achieved rapid economic growth under a regime known as "developmental dictatorship," in which the government targets development as the national priority. After an initial phase of growth, both countries, were weighed down by increased costs associated with economic growth. They entered a phase in which they built a democratic political system from the late 1980s to the 1990s, and shifted their focus to boosting economic added value. This led to the growth of new industries, including semiconductors, and the establishment of Samsung of South Korea and Acer of Taiwan as iconic global brands.

Growth of emerging countries becomes difficult when per capita gross domestic product rises above $10,000, as higher wages push up production costs, making it difficult to compete with newcomers whose wages are still low. Even then, these countries still have to try to develop their industry to maintain economic growth. Such stagnation in growth is called the middle-income trap. For example, Brazil and Malaysia, both of whose GDP per capita has leveled off at around $10,000, seem to have fallen into this trap. South Korea and Taiwan are rare examples of countries that have not fallen victim to it.

University education

According to the International Monetary Fund, per capita GDP rose above $10,000 in nominal terms in 1994 in South Korea and 1992 in Taiwan. The preliminary figures for 2016 were $27,630 and $22,040, respectively. The figure for Japan was $37,300.

Whether or not they regard their income levels as on a par with advanced economies, these figures suggest that both have already risen above the middle-income nation label. But they now face a potential new risk that one might call the "high-income trap."

Typically, as people see their income grow, they start to seek higher education. The percentage of high school graduates who go on to university is about 50% in Japan. But the figures are about 70% in South Korea and over 90% in Taiwan, although these numbers can vary depending on how one defines university. The problem is, while university graduates naturally seek jobs with wages suitably high for their level of education, there are only so many such jobs available. To make matters worse, manufacturers tend to shift their production overseas as domestic labor becomes more expensive, reducing jobs in the country.

Anxiety about job stability among young people is a common problem among high-income countries, and South Korea and Taiwan are no exception.

As their income levels rise, countries also typically experience aging of their population. South Korea's latest total fertility rate, the average number of children a woman gives birth to in her life, is 1.17, while the figure for Taiwan is 1.12 -- both of which are lower than Japan's 1.46. Working-age population -- the number of people aged 15-64 -- started to diminish in Taiwan in 2016, and the figure is expected to start to drop in South Korea this year. A smaller labor force inevitably means slower economic growth. The economic growth rate in 2016 was 2.8% for South Korea and 1.5% in Taiwan. The potential growth rate for both is expected to remain just above 2% for a while. Growth over 3% is no longer an easy target to achieve for either.

As the economy slumps, the country loses stability in society and politics. Politicians tend to turn to populist tactics, boosting unemployment benefits and enhancing elder care to appease the people. A major risk at this point is if the government continues to try to appease people with handsome fiscal spending amid slow growth, it eventually increases fiscal deficit, and long-term interest rates rise. Higher rates and taxes in turn discourage businesses to invest, further stagnating economic growth. Such a negative spiral has tormented the U.S. and European countries in the past.

Innovation -- the only way 

If a high-income country weighed down by high costs wants to maintain growth, one quick way is to bring in foreign workers as cheap labor. But if foreign workers grow excessively numerous, the country's citizens will perceive them as a threat to their jobs. Having seen many Americans and Europeans support politicians who call for expelling immigrants and foreign workers, both Taiwanese and South Koreans would feel cautious about allowing too many foreign workers in.

In the end, the surest path for growth is to realize production growth driven by innovation. Another important factor is that South Korea and Taiwan can no longer look for an example in high-income countries, as they were able to when their incomes were still mid-level. Instead, they now have to create a model for themselves.

When I recall Japan's "lost 20 years," the long period of stagnancy the country suffered, I think that South Korea and Taiwan are both entering a phase in which they cannot achieve stable growth just by replacing leaders and tweaking policies.

Above all, their politicians must be aware that they are now high-income economies. Unless they shed their middle-income mentality, they cannot deal with the high-income trap -- no matter who is leader.

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