After almost four years of Abenomics, global investors are increasingly showing reservations about the effectiveness of zero interest rate policies as a reflationary tool. The missing link has to be the "third arrow" of Abenomics -- a proposed agenda of labor, trade and other structural reforms. In China, the rapid lowering of interest rates and required bank reserve rates has merely served to ramp up corporate debt, raising concerns about souring loans down the line.
Stuck between the two Asian economic powers is South Korea, whose government has been promising reform measures since last year. With exports falling for 15 consecutive months, the country's economic model is facing one of its most difficult challenges since its impressive emergence in the 1980s.
Slowing global growth, coupled with China's growing manufacturing capacity in many industries that South Korea occupies, is pressuring Korea Inc. to urgently revise its so-far successful business model. In addition, a rapidly aging population, echoing that which ushered Japan into deflation in the 1990s, is forcing a rethink on domestic social policy.
On April 13, South Korea will hold elections to fill its 300-seat National Assembly. The next 18 months may be the most pivotal political cycle for South Korea in a long time as the nation strategizes its economic direction in an increasingly competitive and challenging environment. Parliamentary elections, held every four years, traditionally serve as a launching pad for presidential elections, with the next one due in December 2017.
Since the constitution stipulates that a sitting president can serve only a single five-year term, the two main political parties are using the parliamentary election to begin selecting their presidential candidates. The ruling conservative Saenuri Party, which holds half the seats in the current National Assembly, is witnessing jockeying among potential presidential contenders, as is the main opposition Minjoo Party of Korea.
But neither party has published an official policy agenda; instead, individual candidates have offered proposals with little central coordination. One of the most important policy issues is labor reform to allow greater flexibility in hiring and firing.
Just like Japan, the working population of South Korea is facing a structural decline as the birthrate is now one of the lowest among advanced countries. Learning from Japan's deflationary experience, Seoul has been looking for ways to revitalize its labor market by allowing for a redistribution of wealth from older workers to younger ones. The nation's youth unemployment is rising as elsewhere. South Korean youth unemployment amounted to 12.5% in February, against an overall unemployment rate of 4.9%.
One promising measure has been the "wage peak" system introduced last year. This administrative initiative aims to reduce salaries for workers in their 50s who are nearing retirement. Normally in South Korea, wages rise steadily until retirement due to a seniority-based corporate culture. The idea is that a wage peak system would free up payroll to hire younger workers via pay cuts for older ones. Companies can adopt the system at their discretion, and some have done so successfully.
Another urgent reform need regards exporting industries quickly being made redundant by slowing growth and increasing competition from low-cost Chinese producers. In the 1990s, Japan faced a similar situation due to low-cost production from South Korea and other Asian countries, and its companies responded by moving up the value chain or becoming niche players.
As part of decades of industrial planning, the South Korean government has been supporting many industries by encouraging favorable bank lending and other forms of aid. Last year alone, the shipbuilding industry received almost $8 billion in support from the banking sector to remain viable. Despite the capital injection, the companies continue to lose market share at an alarming rate to Chinese rivals. The government's unquestioning support is increasingly being recognized as a wasteful misallocation of state funds.
The public appears to be increasingly willing to accept a reform agenda as the economic situation becomes more troubling. South Korea may yet surprise skeptics in its ability to take aggressive action while the rest of the world continues to rely on ultra-easy monetary policy to help escape from turgid growth.
Unfortunately, South Korea faces a severe handicap in pushing through reforms because of the single five-year presidential term. The short political cycle has resulted in election campaigns being dominated by personalities rather than policy. Both the ruling and opposition parties have become mired in factional fighting, with politicians frequently switching parties to preserve their right to contest parliamentary seats, which highlights the weakness of party ideology and platforms.
For the upcoming legislative and presidential elections, the hope is that voters will show strong support for candidates with policy substance rather than populist agendas. The main political parties have pledged to prioritize job creation but lack concrete plans. One solution proposed by populist politicians is to force the central bank to aggressively ease monetary policy. This would be a dangerous path for Seoul to take given the startling effects of zero interest rate policies elsewhere around the world.
A strong win for Saenuri would provide a boost for President Park Geun-hye and her reform proposals that are currently stuck in the National Assembly. The ruling party is pushing for further wage flexibility, while the opposition is campaigning for a higher minimum wage. The key difference between the two main parties is that Saenuri wants to promote economic growth while the Minjoo Party is promoting "economic democratization" to curb the power of leading conglomerates in favor of encouraging the growth of smaller businesses.
The forthcoming parliamentary election will decide whether the public wants to accept constructive, long-term policies rather than populist promises of short-term gratification based on fear and anger. Observing the political trends in the U.S., the former course would represent a big, positive surprise from a nation that is normally known for resisting full-scale market reforms.
Peter S. Kim is a managing director and investment strategist at Mirae Asset Daewoo Securities. This article reflects the personal views of the author.