South Korea ’ s economyWhat do you do when you reach the top ? To outsiders , South Korea ’ s heroic economic ascent is a template for success . But now it has almost caught up with the developed world it must change its approachNov 12 th 2011 | SEOUL | from the print edition IT IS a crisp autumn morning in Seoul , and a hopeful fisherman sits dreaming by the Cheonggyecheon stream as the world bustles happily by . Glass skyscrapers rise behind him housing the capital ’ s new financial district . The shopfronts at their base are among the swankiest in Asia . Office workers , families and schoolchildren amble past . Busking fills the air . The water tumbles past plum trees and willows . Twenty years ago , this background would itself have seemed a dream for anyone foolish enough to be trying to fish the Cheonggyecheon . Its waters , dirty and hidden , were trapped beneath a roaring highway ; its surroundings were a slum of sweatshops , metal bashing and poverty . The reclamation of the Cheonggyecheon , one of the great urban - regeneration projects of the world , has about it the air of a dream achieved . So , to a large extent , has the Korea through which the stream flows . Related topics Small businessUnited StatesSamsungOrganisation for Economic Cooperation and DevelopmentAsiaIn 1960 , in the aftermath of a devastating war , the exhausted south was one of the poorest countries in the world , with an income per head on a par with the poorest parts of Africa . By the end of 2011 it will be richer than the European Union average , with a gross domestic product per person of $ 31 , 750 , calculated on a basis of purchasing - power parity ( PPP ) , compared with $ 31 , 550 for the EU . South Korea is the only country that has so far managed to go from being the recipient of a lot of development aid to being rich within a working life . For most poor countries , South Korea is a model of growth , a better exemplar than China , which is too vast to copy , and better , too , than Taiwan , Singapore or Hong Kong . All three are richer than Korea but all are , in different ways , exceptions : Singapore and Hong Kong are city states , while Taiwan ’ s disputed sovereignty makes it sui generis . South Korea has not merely grown fast . It has combined growth with democracy . Though its spurt began under a military dictator , Park Chung - hee , for the past 25 years the country has had a vibrant parliamentary system . Korea scores the same as Japan in the democracy tally kept by Freedom House , a think - tank in Washington , DC . No other Asian country does as well . At the same time Korea has combined growth with equity . Between 1980 and 1997 , its Gini coefficient , a measure of income inequality , fell from 0 . 33 to an exceptionally low 0 . 28 , before rising back up during the 1997 - 98 Asian crisis . In 2010 , the level was 0 . 31 , a bit worse than Scandinavian countries , a bit better than Canada . A model that workedNow Korea can add resilience to its roster of achievements . It was walloped during the global financial crisis , but recovered faster than any other rich country . Between June 2008 and February 2009 , Korea lost 1 . 2 m jobs . South Korea ’ s relatively open financial system made it vulnerable to the volatility in world markets , a vulnerability that continues . This September , foreigners withdrew over 1 . 3 trillion won ( $ 1 . 1 billion ) from the stock market and the currency slumped 10 %. Yet in 2010 , GDP grew by 6 %. This year ’ s expansion is likely to be 4 %. The unemployment rate is now a covetable 3 %. Some of the recovery is the result of Korea ’ s happy dependence on China : it exports more capital goods to China relative to the size of its economy than anyone else , even Germany . But this is only part of the explanation ( which is just as well given China ’ s slowdown ) . The government also initiated a public - works scheme that is mopping up over 2 % of the labour force . It introduced an old - age pension and began , then expanded , an earned - income tax credit . All this from President Lee Myung - bak , who was once chief executive officer of Hyundai Construction and is widely assumed to be excessively friendly to big business . Korea ’ s relentless convergence towards America ’ s standard of living ( see chart 1 ) has barely missed a beat . China ’ s dollar GDP per person would have to grow at 7 . 5 - 8 % a year for 20 years to reach the heights Korea has already scaled . If the Korean economy goes on growing at 4 . 5 % a year and America ’ s at 2 . 5 %, Korea would overtake America ( in PPP terms ) only a few years later . To keep growing that impressively , though , Korea will need some new tactics . And it will need to develop them from scratch . When a country or a company is playing catch - up it can look at what others are doing and do it better . This Korea has done well . Hyundai has outcompeted Toyota in the market for reliable , efficient , cheap cars . Korea ’ s shipyards have beaten everyone through economies of scale . All changeBut this way of doing things works only when others have blazed a trail before you . As you join the ranks of the richest , you run out of beaten track to follow . Your economy comes to depend more on innovation and on learning from your own mistakes than on improving on the successes of others . The South Korean model of 1960 - 2010 remains an example for developing countries ; but Korea itself now needs something new . The Korean model had four distinctive features : a Stakhanovite workforce ; powerful conglomerates ; relatively weak smaller firms ; and high social cohesion . All these are either coming under strain , or in need of reassessment , or both . South Koreans lay great store by education and hard work . They put in 2 , 200 hours of work a year , half as much again as the Dutch or Germans . Their reaction to the 2008 slump was to work harder still . During the 2009 - 10 recovery , reckons Richard Freeman of Harvard University , Korea had the second - largest increase in hours worked in manufacturing , after Taiwan . And the quality of labour has been even more important than the quantity . Along with Finland and Singapore , Korean schools regularly top international comparisons of educational standards , such as those run by the Organisation for Economic Co - operation and Development ( OECD ) , a rich - country club . Korea spends a larger share of GDP on tertiary education than any rich country other than America . Given relatively low wages , this superbly educated workforce is hard to beat . But with Korea already top of the league tables , it is harder to generate further jumps in income from big increases in hours and skills . Indeed , the immediate problem is merely to maintain its excellence . According to Yeong Kwan Song of the Korean Development Institute ( KDI ) , a think - tank , companies are starting to worry that graduates are emerging from university with the wrong skills . on some estimates , half of recent graduates are failing to find full - time jobs and are going into further study or part - time employment . So while general education remains good , some industrial skills may be declining . One way to boost the skilled labour force might be to have rather more people working rather fewer hours . The extra people would be women , often highly educated ones . Quite a lot of Korean women stay at home — the participation rate for women aged 25 - 54 is only 62 %, the fourth - lowest in the OECD — even though they are usually better educated than men . In almost all rich countries , the best - educated women are more likely to work than their less - educated sisters . Not in South Korea . Shorter hours might encourage some of these skilled women into the workforce . So might a change in attitudes to schooling . The job of supervising a child ’ s education falls to women , which is one of the reasons why relatively few women have jobs . This does not mean that they have a lot of children instead . Korea has a fertility rate of 1 . 2 , one of the lowest in the OECD . This is in part because those good educations make having children a pricey proposition . An unusually large part of the spending that makes Korean education so good is private , not public . The government spends just under 5 % of GDP on education , slightly below the rich - country average . Families add an extra 2 . 8 % of GDP on top of that , easily the highest rate in the OECD . At universities , family spending is three times that of the state . And families spend an estimated 8 % of their household budgets on after - hours programmes for each child , an investment which explains the effort mothers put into making sure it pays off . If you have three children , their after - school activities alone could swallow up a quarter of the household budget . The power of conglomerates . Much of South Korea ’ s miracle has been the work of big conglomerates , or chaebol . Barry Eichengreen of the University of California , Berkeley , argues that they are “ among the most technologically and commercially progressive agents in the Korean economy ” . Samsung Electronics , for instance , one of 83 constituent parts of the Samsung empire , sells more smartphones than Apple . Korea ’ s shipyards have just started work on a new class of container ships called the triple E - class which are easily the largest container ships ever built ( Maersk , the ships ’ buyer , says the three Es refer to economy of scale , energy efficiency and environmental cleanliness ; simpler just to see them betokening EEEnormity ) . Korea ’ s large companies employ slightly less than a quarter of the workforce and produce more than half the country ’ s output . Chaebol - alikes exist round the world , from Carlos Slim ’ s Group Carso in Mexico to Lee Ka - shing ’ s holdings in Hong Kong . The surviving chaebol have proved resilient . During the 1997 - 98 crisis , some chaebol ’ s debt - to - equity ratios soared to over 500 %; half of them went bust and conglomerates were widely seen as a drag on the economy . Now , those that came through the time of trial have returned to profitability and respectable debt ratios — but their success still has a downside . After the founding fathersThe chaebol system has proved prone to fraud , dodgy accounting and illegal political contributions . Many of the companies depend to an unhealthy degree on a founder or his family . About half the managers of Samsung ’ s firms used to work in the chairman ’ s secretariat — and thus directly for the founder or his son — and owe their promotion to the associated patronage . As with any family business , the moment of greatest danger is when the leadership passes to the next generation . Samsung passed this test in 1987 when the founder handed over to his son , Lee Kun - hee . Now Mr Lee ’ s son , Jay Y . Lee , has been appointed chief operating officer of Samsung Electronics and a new transition looms . If Mr Lee the third has business acumen , fine . If not , the whole country could suffer . Find out how much of an Apple iPhone is actually a Samsung with our " teardown " infographicMoreover , there are signs that the chaebol may be stifling innovation and entrepreneurship . They have proved expert at applying and improving existing technology , even the high technology of touch - screen smartphones . But except in some internet businesses and computer gaming , South Korea has few start - ups or cutting - edge technology firms . It lacks nationwide venture - capital businesses , says Hasung Jang , the dean of Korea University ’ s Business School , because each chaebol has one of its own . The firms snap up the best and brightest and turn them into company men . Mr Jang compares the conglomerates to light - hogging trees in a forest : their canopy may be impressive , but it is hard for anything to grow underneath . Koreans perceive fewer opportunities for entrepreneurship than any of their peers in rich countries except Japan , according to an annual survey by the Global Entrepreneurship Monitor , set up by the London Business School and Babson College , Massachusetts . As South Korea moves towards the technological frontier , such attitudes will have to change . Innovation is not going to come if everyone shelters from risk in the chaebol . Weak small firms . There is a huge productivity gap between Korea ’ s export - oriented chaebol and small and medium - sized firms ( SMEs ) which dominate services . Value added per worker in small firms is less than half that in large ones . SMEs ’ operating profits were 4 . 5 % of sales in 2007 , compared with about 7 % for large firms . Small firms spend about half as much on research and development as large ones per unit of sales and borrow far more relative to assets . Over time , their performance seems to be getting worse . Korea , in short , has first - world manufacturing exporters and third - world services . Coddled , not copingThere are several reasons for the mismatch . Small firms are crowded out of markets for people and skills by the chaebol . And because chaebol pay scales often rise according to years in service , they squeeze wage bills by firing older workers , with the service sector working as a recycling system for surplus labour . Small firms have also been coddled by the government . Korea maintains various entry barriers to shelter mom - and - pop stores from competition . Government support to SMEs rose from under 6 trillion won in 2008 to 10 trillion in 2009 . Public credit guarantees rose from 33 trillion won in the Asian crisis to almost 60 trillion won in 2009 . Last year , the government “ requested ” banks to roll over their loans to small firms . Randall Jones of the OECD argues that all this help has made SMEs less , not more , efficient , and damaged competitiveness . The richest economies are switching into services that in Korea are dominated by small firms which cannot compete . Social cohesion . Korea ’ s equal distribution of income is changing . Judging by the relationship between the richest and poorest tenth , Korea is becoming more unequal than it used to be . Worse , the growing number of poor people is disproportionately elderly . In other rich countries , people between 66 and 75 are no more likely to be poor than the population as a whole . In Korea , they are three times as likely to be poor . This is all the more worrying because the low birth rate means the country is ageing more rapidly than any other rich country . In 2009 , people over 65 were outnumbered ten to one by the working - age population . By 2050 , there will be seven over - 65 s for every ten working - age adults . Disproportionate old - age poverty would have a huge impact on the social backing for policies designed to foster growth . Not to be left behind Korea ’ s equitable income distribution used to provide a sense that society as a whole was benefiting from breakneck catch - up . But discontent is rising both about inequality and about the role of the chaebol , producing growing disenchantment with both main political parties . The recent election for mayor of Seoul produced an upset win for a left - wing anti - establishment maverick . It is proving hard to resist the trend towards inequality because of another basic feature of Korea ’ s economic model : total tax revenues are just 26 % of GDP . Taxes are especially low on labour , a choice designed to boost work and foreign investment . But as a result , social spending is low ( 11 %); public spending on family benefits is exceptionally low ( less than a quarter of the rich - country average ) ; and the tax - benefit system is the worst in the OECD at reducing inequality and poverty . Korea ’ s tax - benefit system reduces poverty by only 18 % ( compared with what it would have been without the benefits ) . Sweden ’ s tax - benefit system cuts its poverty rate by 80 %. Korea , argues Mr Jones , needs to increase taxes and social spending in order to reduce poverty and inequality . one reason it is reluctant to do this is because it is afraid of the impact on jobs . Its changing demography also suggests caution in expanding the social safety net too fast or far , as it will be used ever more over the decades to come . And then there is the ever - present imponderable : the possible need , at some point , to finance the horrendous costs of reunification with destitute North Korea when that state collapses . That would make the vast expense of unification in Germany pale into insignificance . At some point in the future Korea may need all the room for future fiscal expansion it can get . A bridge to the future The problems of the South Korean model should not be allowed to obscure either its achievements or its continuing strengths . True , over the past 40 years annual GDP growth has declined from about 10 % to 4 - 5 % ( see chart 2 ) . Business investment has halved from over 30 % of GDP in the mid - 1990 s to 17 % in 2010 — but that is still 50 % over the OECD average . Further declines in growth seem likely . That is not surprising . As Kwanho Shin of Korea University and Dwight Perkins of Harvard show , every country ’ s growth starts to ebb as its income reaches about $ 10 , 000 a year . South Korea has kept going longer than most . If it can increase public spending a little to reduce inequality and poverty , boost its labour supply by encouraging more women to work and avoid compromising its educational standards and penchant for hard work , then it should be well placed to pull ahead of Europeans and catch up with America , too . South Korea has long been a model for outsiders . President Kennedy ’ s chief economic adviser , Walt Rostow , wanted to use it as a testing ground for his theories about stages of economic growth . But Koreans do not see themselves as a blank slate , or as a new world power . They stress a long legacy of openness and innovation . Before the wars of the 20 th century Korea was a bridge between the more closed worlds of China and Japan . It developed movable metal type two centuries before Gutenberg ; its last imperial dynasty benefited from checks and balances more extensive than in its Chinese prototypes . The more Korea brings these qualities of domestic innovation to the fore , the better its chances of blazing a new trail for itself . from the print edition | Briefing