A major geoeconomic event occurred in 2018 when South Korea’s real GDP per capita surpassed that of Japan. By 2026, the International Monetary Fund projects that South Korea will be 12 per cent ahead of Japan.

What makes this event all the more important and illuminating is that South Korea shares so many of Japan’s structural flaws. South Korea’s ability to ameliorate those flaws provide lessons for Japan.

The measure used to calculate ‘real’ GDP is called Purchasing Power Parity, which eliminates distortions caused by varying price levels and gyrations in exchange rates.

How South Korea overtook Japan

South Korea overtook Japan because its growth in productivity has outpaced Japan. Until the early 1990s, Japan was rapidly catching up to the United States. Its productivity peaked at 71 per cent of the United States’ level in 1997. Since then, it has fallen back to just 63 per cent. By contrast, South Korea’s productivity has continued growing and is now just a few percentage points behind Japan.

But that begs the question: how did South Korea manage to do so when it shares so many of Japan’s economic flaws?

Like Japan, South Korea is a ‘dual economy’ — a hybrid of extremely efficient exporting sectors, and woefully inefficient domestic manufacturing and services sectors. The productivity gap between South Korea’s corporate giants and its small and medium-sized enterprises (SMEs) is the third worst in the OECD.

What happens if Samsung falters?

South Korea’s economy is so lopsided that Samsung Electronics accounted for an astonishing 20 per cent of all South Korean exports in 2019. What happens if Samsung falters? Meanwhile, more than a third of the country’s labour force consists of low paid non regular workers. The OECD has reported that these structural economic defects in South Korea lowers its potential growth rate by 1–2 percentage points.

Despite these structural flaws, South Korea has managed to avoid Japan’s fate by getting more of the ‘basics’ right. As detailed below, it has also made more serious efforts to address its structural defects. Without such reforms, experts had warned that South Korea could share Japan’s fate.

Stability in macroeconomic demand

South Korea has managed to create stability in macroeconomic demand to create resilience in the face of economic shocks. Wages have risen in tandem with overall GDP. This eliminates the need for chronic government deficit spending to stoke demand — a problem that persists in Japan.

From 1990 to 2020, the average Japanese worker enjoyed virtually no increase in real wages. Meanwhile, South Korean workers saw their pay double to a level higher than in Japan. As a result, South Korea’s GDP rose by 4 per cent even as Japan’s fell 7 per cent during the 1998 global financial crisis. During the first two years of COVID-19, Korea’s GDP rose 3 per cent while Japan’s fell 3 per cent.

Raising Productivity

Raising productivity growth requires an abundance of capital investment. In 1980, South Korean laborers had less than one-sixth as much capital to work with as their counterparts in Japan for each work hour. By 2019, they had 95 per cent as much.

South Korea has also invested more efficiently. South Korean companies get almost twice as much economic benefit per dollar of investment as those in Japan. While both countries suffer from a digital divide between corporate giants and SMEs, South Korean companies who do invest in information and communications technology have exploited its potential much more effectively. When 64 countries were ranked in 2021 on ‘business agility’ in the digital area, South Korea came in 5th place. Japan lagged behind at 53rd.

Human capital is key to raising productivity

Acquiring the latest technology has minimal benefits unless managers and workers have the skills to use it imaginatively. Human capital measures the amount of schooling each person receives and also how effectively that education contributes to growth. In 1960, South Korean human capital was only 70 per cent of Japanese counterparts. By 2019, it was 5 per cent more.

A key contributor to Japan’s lag is less spending by Japanese companies on off-the-job training, which has dropped 40 per cent since 1991.

Innovation only flourishes when new companies with new ideas have genuine opportunities to challenge incumbents. Politicians in both Seoul and Tokyo talk about encouraging entrepreneurship, but South Korea is turning more of its rhetoric into action. In Japan, only 12 per cent of government financial aid to research and development goes to companies with less than 250 employees, the least among OECD countries. In South Korea, half of the financial aid goes to SMEs.

There is a silver lining to Japan’s declining growth in real GDP per capita. South Korea’s experience shows that the right structural reforms can spur sustainable growth and raise real living standards.

Author: Richard Katz, Carnegie Council for Ethics in International Affairs 

Richard Katz is a Senior Fellow at the Carnegie Council for Ethics in International Affairs.

A version of this article first appeared in Toyo Keizai magazine.

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