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Report VOD

Effects of Revolving Doors in the Financial Sector
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The revolving door practice, i.e. the recruitment of ex-regulators by regulated firms, has long been subject to criticism in Korea. Despite its importance, however, there are few studies on the economic impact of the revolving door. By applying a unique dataset of financial firms in Korea, it was found that the practice does not improve the financial soundness of the recruiting firms. Additionally, it was observed that firms, shortly after hiring former regulators, are less likely to receive regulatory penalties. This result appears to be associated with Korea’s financial supervisory system, wherein the majority of supervisory tasks are concentrated within a single agency.

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    In an aging society there are 7 seniors out of every one hundred people, while an aged society has 14 and a super-aged society has 20.

    Korea is expected to enter a super-aged society in 2026.

    In fact, at the current pace of aging, Korea is on track to become a super-aged society 10 years faster than Japan.

    In terms of the working-age population, Korea’s 65-plus population will grow 1.7 times faster than Japan from 2015 to 2050.

    And the share of the senior population will equal that of the working population in 2050.

    So, what are the economic repercussions of a rapidly aging population?

    KDI conducted an analysis based on the labor force participation rate by age group in 2017,
    assuming 3 scenarios to estimate the economic growth rate for the coming three decades.

    Firstly, assuming that the labor force participation rate remains unchanged during the period,
    the economic growth rate will average 2.0% in the 2020s and 1.0% in the 2040s.

    Next, taking into account Korea’s lower employment rate for women than for men, estimates were made for the growth in the participation rate of women.

    For this, Sweden’s employment structure, which has a small gap between men and women, was applied.

    However, the results showed that the economic growth rate declined.

    Growth trends again failed to improve when the employment structure of Japan, who underwent population aging before Korea, was applied.

    The reason for the lack of improvement is because the number of retirees far outnumbers that of the working population.

    As a result, even a high participation rate is inadequate to offset the decline in the labor supply.

    Accordingly, unless significant improvements are made in productivity through measures to expand the substitute labor force, which includes women and young people, efforts to counter population aging will remain limited.

    Additionally, the results revealed that in order to ease the downtrend in economic growth,
    the labor participation rate of women must be at a similar level to Sweden and that of men to Japan’s while the senior participation rate is at Korea’s level.

    The involvement of the senior population in economic activities will not only ease the decline in economic growth but also reduce the dependency ratio, serving as an effective countermeasure to population aging.

    [Interview with the author]
    The most effective means in terms of responding to population aging is utilizing the senior labor force. And, there are many prerequisites for this, including overhauling the retirement age system and adjusting the wage system.

    In addition, we must move away from the social norms of perceiving the over 65s as dependents or surplus. A new life cycle must be established for the senior generation, and the population should be granted opportunities and roles to productively contribute to society.

    It is true that compared to the quantity, the quality of Korea’s senior labor market remains subpar.

    However, the baby boomers who will soon retire are far more educated than the preceding senior generation. As such, their employment and their productivity in the senior labor market is also expected to increase. In particular, policy efforts must be ramped up in terms of providing vocational training and lifelong education programs to assist those looking to change careers later in life.
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    Korea’s economic growth rate dropped to a yearly average of 3% in the 2010s, raising concerns over growth potential.

    The economic growth rate is an indicator for the growth in the sum of all products and services that are produced by a country.

    As total output is determined by labor, capital input and productivity, we are able to see the contribution rate of each factor to economic growth.

    Accordingly, KDI conducted an analysis of the contribution of production factors to the decline in economic growth.

    It was found that there were no meaningful changes in labor input while a slowdown was seen in physical capital and total factor productivity or TFP.

    Declines were also evident in these two factors in the per capita economic growth rate, implying that the value-added created by and the labor productivity of an individual has also dropped.

    The decline in physical capital contribution is often seen when an economy reaches maturity.

    In Korea, this means that the downtrend in TFP growth was the major driver of the fall in growth, and not that investments have stagnated.

    Then, why is productivity growth falling?

    Improvements in the determinants of total factor productivity i.e systems, efficient resource allocation, education and human capital among others may have slowed.

    On the other hand, the fall in external demand resulting from the slow growth in international trade following the global financial crisis may have been a contributing factor.

    In fact, since the financial crisis, Korea’s goods export has declined and the growth in labor productivity, especially manufacturing, has deteriorated significantly.

    The IMF concluded that the fall in growth suffered by the majority of countries following the global financial crisis propelled the fall in growth potential. It also expects that it will take a considerable amount of time to return to pre-crisis levels.

    Due to such conditions in the world economy, it is hard to expect that Korea’s labor productivity will swiftly respond to a recovery in external demand.

    Based on the analysis, it is expected that Korea’s growth rate in 2020 will mark a high 1% if conditions remain the same, and a low-to-mid 2% if there is an uptick in productivity on continued innovation.

    The economic growth rate per capita is also expected to stand between a high 1% to a low-to-mid 2%.

    (Interview with the Author)
    The growth of Korea’s economy is expected to decelerate even further in 2020 considering the population aging factor. Responding to the falling growth trend with active fiscal policies could be effective in the short-term, but a recurrence will place a strain on government finance. If efforts were concentrated on enhancing productivity, the decline in the growth rate could be eased in the long-term. From a institutional or resource-allocation perspective, Korea still has sufficient room to improve productivity.
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    Household debt poses a serious risk to the Korean economy.

    Advanced economies have shown for the past 130 years that an excessive growth of private loans leads to longer and more severe recessions.

    The significance of financial stability has become widely recognized since the global financial crisis, and has led many countries to strengthen their macro-prudential management to avoid excessive loan-taking.

    After the global financial crisis, the majority of OECD countries adjusted their household debt ratios.

    In Korea, however, household debt has doubled in size, despite the countless warnings and government actions, and the risks are snowballing.

    So, why have past policies failed to contain the situation?

    Macro-prudential policies can enhance social welfare through financial stability, but this requires a long-term effort.

    And because the policies restrict excessive amount of loans to reduce the risks of financial instability, it is difficult to gain public support during recessionary periods when production and employment are low.

    They also generate resistance from interest groups due to their impact on the loan and real estate markets.

    It may be theoretically shown that, the more policy makers are fixated on the short-term outcomes, the more likely they are to choose stimulus packages that entail excessive debt, despite their concerns over financial instability.

    On the other hand, those who prioritize long-term gains will select macro-prudential policies that sustain financial stability rather than short-term stimulation of the domestic demand.

    The pursuit of short-term gains is exacerbated by Korea’s short election cycles, with important elections occurring every one to two years.

    In fact, after the global financial crisis, decision-makers ignored the warning signs about the state of household loans, and adopted not only monetary and fiscal policies but also stimulus measures that would ease loan regulations in the hopes of reviving the economy in 2014.

    Given the high preference for short-term results, it would be difficult to effectively pursue macro-prudential policies to achieve financial stability.

    (Interview with the author)
    In order to improve the macro-prudential management system,
    institutional mechanisms must be put into place to prevent the horizon of decision-makers from narrowing. In the UK, the central bank is guaranteed independence as the enforcer of macro-prudential policies which deters tendencies to focus on the short-term gains. In the case of Australia and Canada, a separate financial supervisory institution implements such policies with the openness and transparency of the decision-making process. Taking a cue from these countries, the independence and accountability of the institution that implement macro-prudential policies in Korea must be strengthened by guaranteeing tenure and adopting an evaluation and compensation system for top decision-makers to encourage them to pursue the longer-term benefits.
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    Retired financial regulators often find their way to executive positions in the private sector.

    To explain the economic impact of such a practice, also known as “revolving door,” there are two hypothesis.

    The first looks at the practice from a positive perspective, explaining that by hiring ex-regulators as executives, financial firms can utilize their expertise and experience to improve financial soundness.

    The other takes a more negative stance, speculating that financial firms can use the ex-regulators’ connections to unjustly avoid being penalized by the financial authorities.

    So, does this really happen?

    To answer this question, KDI empirically analyzed the economic impact of ex-financial regulators joining private firms.

    Firstly, an examination was conducted into whether ex-regulators actually contribute to the performance and improvement of the firms’ financial risk management.

    Based on data of ex-regulators hired by financial firms from 2011 to 2017, The analysis revealed that there were no discernable changes within the first three months of appointment,

    and while those from the Bank of Korea contributed somewhat, the remaining ex-regulators did little to improve the hiring firms’ financial risk management.

    Next, an analysis was conducted to see whether the probability of a firm being penalized by the financial authorities changed after the appointment of an ex-regulator.

    It was found that for firms whose executives had previously served in the FSS, the probability of regulatory action dropped by roughly 16% in the first 3 months.

    This is much higher than when firms tried to curb the probability by reducing their non-performing assets.

    Nevertheless, the analysis also revealed that this advantage disappears during the following three months.

    Then, does the probability of regulatory action decrease because ex-regulators reduce non-financial risks such as personal information leaks?

    An examination into whether there were, in fact, changes in the management of operational risks while the probability of regulatory action diminished found no such changes.

    That is, the probability of regulatory action decreased despite the lack of improvements in the financial soundness of firms after the appointment of an ex-regulator.

    In the US, where there are also many such cases, there were clear improvements in the firms’ financial performance while there was little change in the probability of regulatory action.

    So, why is there a discrepancy between Korea and the US?

    The answer lies in the fact that the US’ financial supervisory system has a decentralized structure while Korea’s is centralized and within which the majority of duties tied to financial supervision is undertaken by a single institution.

    Indeed, if the authority was granted to numerous institutions, it would create the necessary checks and balances which, in turn, would make it difficult for financial institutions and private firms to collude.

    Also, from the firms’ point of view, it would make it more difficult to form ties with a large number of regulators.

    [Interview with the author]
    (Keeyoung Rhee, Fellow at KDI)
    If the current financial supervisory system itself incentivizes improper practices, a shift to a decentralized supervisory structure can be discussed. But, such a process is expected to entail substantial economic costs, so we also need to seek measures to reinforce the accountability of the supervisory authorities while maintaining the centralized system.
    For example, the government can establish an information-sharing mechanism wherein all regulatory agencies have free access to the information on the risks of financial firms, which is mainly held by the FSS in the current system.

    (Sunjoo Hwang, Fellow at KDI)
    This study is meaningful in that it analyzes the economic impact of the revolving door practice, which has long been subject to criticism. However, there are limitations and while we were able to fully use the data avaliable, we still lacked information in certain areas. One example is the operational risk indicator in relation to the financial supervisory regulations, which was used in this study. However, the indicator is limited in fully capturing the non-financial risks of financial firms. Therefore, following studies should collect further data to analyze the effects in more detail.
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    In 2017, the government began making efforts to convert the employment status of workers in the public sector from non-regular to regular, in order to ease the duality of the labor market.

    So, is this possible in the private sector?

    To convert non-regular workers into regular workers in the private sector, an environment must be created in which firms are encouraged to take the initiative.

    Accordingly, KDI conducted an analysis on the impact of the non-regular employment protection law in 2007 on the employment decisions of private firms.

    Since the enactment of the non-regular employment protection law, firms are obligated to convert fixed-term workers to
    non-fixed term after two years.

    Firms are also prohibited from discriminating against fixed-term works.

    So, what has happened to the employment in firms?

    Despite an increase in the share of regular workers, there has been a decline in total employment while the use of other non-regular workers not protected by the law, such as contract workers, has also increased.

    In addition, firms without a labor union experienced a relatively large increase in the number of regular workers while those with a union saw a marked rise in that of other non-regular workers.

    Then, what are the thoughts of the firms themselves regarding the regulations?

    KDI questioned the CEOs of 1,000 randomly selected firms about their intentions to convert the status of fixed-term workers to non-fixed term or regular as well as their treatment of them.

    The survey was then analyzed according to firm characteristics
    such as difficulties in amending working conditions, number of employees, labor union, work complexity. etc.

    With all other variables constant, the analysis found that firms that had more difficulties in amending working conditions,
    including wages, working hours and welfare, were more unfavorable towards converting to regular status and to equal treatment.

    Also, when variables such as difficulties in amending working conditions were controlled, the presence of a labor union had no significance in the conversion and fair treatment of non-regular workers.

    This implies that perceptions about amending working conditions
    has more bearing than whether there is a labor union.

    (Interview with the author)
    Policies on non-regular employment thus far have mainly centered on lawfully regulating the use of non-regular workers. However, the regulation alone cannot resolve the dual structure of the labor market and may even escalate unemployment and outsourcing.

    Conventional notions about labor flexibility needs to be shifted away from employment to working conditions, which includes wages and working hours, to evenly promote job stability for the workers and flexible labor management needed by firms.
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    The gap between private consumption and domestic consumption is growing.

    So, what is the difference between the two?

    Private consumption is the total spending of the residents of a country both at home and abroad.

    And domestic consumption is the total spending of both residents and foreigners within the same domestic territory.

    In Korea, domestic consumption by foreigners is more closely associated with production by consumption-related industries
    than the overseas private consumption by residents.

    Despite the relatively rapid recovery in private consumption, production by consumption-related industries recovered less in 2017, implying a relatively weaker correlation between the two.

    This is mostly due to the decline in total domestic consumption
    as foreigners tightened their purse strings.

    So, how significant is the domestic consumption by foreigners in Korea?

    KDI analyzed the impact of domestic consumption by foreigners
    on consumption-related industries.

    It was found that although the share of domestic consumption by foreigners in total domestic consumption is small,
    its contribution to the volatility of domestic consumption
    has grown over the years.

    On a one point increase in the standard deviation of domestic consumption by foreigners, the value-added in the services and
    food and accomodations industries and the growth rate in services consumption would all increase.

    This has been particularly stronger in recent times.

    During the global financial crisis, the shocks delivered to Korea’s domestic consumption were eased as domestic consumption by foreigners increased, offsetting the huge slump in that of the residents.

    In 2017, however, foreigners spent 28% less than the previous year,
    slashing the growth in total domestic consumption by 25%.

    So, why did the spending of foreigners in Korea take a downward turn?

    The domestic consumption by foreigners is closely tied to the foreign exchange rate. Therefore, any movements in the rate will
    typically be reflected in the spending.

    In 2017, however, factors other than the exchange rate were
    primarily responsible for the decline.

    To delve further, an examination was conducted into the number of tourists that visited Korea in 2017.

    It was found that due to geopolitical issues, including the relocation of Thaad, Chinese tourists, who make up half of all tourists in Korea, fell by a record-breaking 55% compared to the previous year.

    And as a result, the total number of foreign tourists dropped by a quarter.

    The number of Chinese tourists still has not recovered to past figures, and it is weighing down on the recovery of
    production by consumption-related industries.

    It is expected that this trend will continue, with domestic consumption being affected by the rebound in the number of visitors to Korea, especially those from China.

    [Interview with the author]
    Korea’s total domestic consumption stalled in 2017 due to the significant fall in the expenditure of foreigners, especially those of Chinese tourists whose numbers dropped by over half.
    This implies that together with the traditional export industry, China will also have a big impact on consumption-related industries.

    In order to prepare for future economic contractions, efforts must be made to secure the flexibility of the FX rate to ease the fluctuations in domestic consumption. Also, consumption-related industries such as services must enhance their competitiveness to meet the demands from their possible growing exposure to external markets.
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    Unemployment is rising.
    But, what is causing it?

    Generally, unemployment occurs when there is not enough jobs or when there are vacant jobs but they are not well connected to the unemployed, referred to as a job mismatch.

    Korea’s job deficiency and job mismatch has worsened since 2014.
    The unemployment rate is on a continued increase and it has been rising even faster in recent years.

    Accordingly, KDI conducted an analysis to examine the recent increase in the unemployment rate from both a job-deficiency and job-mismatch perspective.

    Mismatch unemployment was divided into industry-level and other mismatch unemployment. The former occurs when unemployed workers are unable to move seamlessly across industry due to restrictions such as wages and information and the latter due to the age structure and other factors.

    From 2014 to 2017, other mismatch unemployment took the largest share of the average unemployment rate during the period.

    The order in which the factors influenced the fluctuations in the unemployment rate, however, which is vital to unemployment policies, was job deficiency, industry-level mismatch then other mismatch.

    The results showed that the main cause of the rising unemployment rate in 2014 to 2017 was the industry-level mismatch and lack of jobs.

    After 2015, the restructuring in the shipbuilding industry scaled down jobs in manufacturing while the housing boom meant that there was an ample supply in construction. This exacerbated the industry-level mismatch since the unemployed in manufacturing were unable to move smoothly into the construction industry.

    Meanwhile, the economic slowdown, which started a year earlier in 2014, curbed the demand for labor.

    In 2018, the unemployment rate is rapidly climbing.

    Using up-to-date statistical data and the same analysis methods it was found that the changes in the current unemployment rate are being driven firstly by the lack of jobs then other mismatch and finally industry-level mismatch.

    The restructuring of the manufacturing and service industries, recession in construction, and rising labor costs seem to be exacerbating the shortage of jobs.

    With the exception of the third quarter of 2018, the unemployment rate has become very sensitive to economic fluctuations.

    (Interview with the Author)
    Analysis results reveal that the rise in Korea’s unemployment rate since 2014 can primarily be explained by the industry-level mismatch and lack of labor demand. In 2018, particularly, the lack of labor demand became more severe. To resolve the unemployment issue, the government must promote the labor demand from existing firms through expansionary aggregate demand policies while supporting the entry of new firms in order to establish an environment where more jobs are created. Meanwhile, the rigidity of wages and working conditions must be eased to reduce the industry-level mismatch. This will improve the labor market to enable workers to move smoothly between industries.
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    Despite sanctions from the international community, North Korea’s trade volume realized two decades of consistent growth starting from 1996.

    However, while it is common for an economy to grow in line with the growth in trade, North Korea’s economy remains lackluster.

    Quality as well as quantity is a vital factor in long-term economic growth. That is, “what” is exported is as important as “how much”.

    And, North Korea has fallen short in this aspect.

    Why? In order to find out, KDI first analyzed the changes in North Korea’s exports for the past 20 years.

    Until 2001, North Korea’s largest trading partner was Japan, and its exports were diverse, including mineral products, electronic parts and seafood.

    In 2002, however, China replaced Japan, intensifying North Korea’s dependency.

    Indeed, in 2016, China’s share of North Korea’s overseas trade marked a staggering 90%. And the share of anthracite has grown rapidly since the late 2000s.

    The boom in anthracite exports derives from the surging demand for fossil fuel products due to China’s rapid economic development.

    Also, North Korea strategically expanded its anthracite export to China in response to international sanctions which have restricted the inflow of foreign currencies.

    So, what does this trade structure-bias towards China and anthracite mean for the North Korean economy?

    An examination was conducted into the level of physical and human capital input required to produce specific items and a comparison was made with Vietnam.

    Vietnam has also seen a sharp increase in its export volume during the past 20 years. But, that is where the similarities end.

    While North Korea’s quality of input has continued to decline since the mid-2000s, that of Vietnam’s has continued to increase.

    The underlying source of the disparity lies in the changes in the items themselves.

    Vietnam, whose economy underwent structural reform in the late 1980s, has achieved both quantitative and qualitative growth in its trade volume. It has upgraded its export items from agricultural products in the 1990s, apparels in the 2000s and electronic parts from 2010 onwards.

    The fruits of such progress has been consistent economic growth.

    On the other hand, North Korea seems to have moved in the opposite direction, from exporting diverse items including electronic products in the 1990s to exporting mainly anthracite, which requires little technology and capital, from the mid-2000s.

    In fact, North Korea’s anthracite trade with China has concentrated production resources on the coal industry.

    And, if this China- and anthracite-dependent export structure becomes a permanent fixture, it will weaken North Korea to external shocks in the short-term and distort the allocation of resources in the long-term, eventually diminishing the competitiveness of other industries.

    [Interview with the author]
    The Korean government must consider the changes in the trade structure of North Korea and seek economic cooperation measures which could drive North Korea’s long-term economic growth.
    Specifically, after sanctions have been lifted, North Korea must cooperate with the international community to transition away from its one-sided trade with China to become a normal economy that trades in diverse items.
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    In order to foster future growth engines, major countries around the globe are formulating strategies to integrate cutting-edge technology with the manufacturing industry.

    And, at the center of the strategies are creative and innovative young firms.

    Young plants have played a key role in production and job creation in Korea’s manufacturing.

    However, the industry is now aging with the share of young plants dropping by almost 50% in the last 20 years.

    So, is this to blame for the industry’s shrinking competitiveness?

    KDI conducted an analysis to examine the impact of young plants
    on the productivity growth of manufacturing.

    After dividing manufacturing plants into young plants under
    5 years old and old plants over 6,

    it was found that although young plants created less value-added
    than their older counterparts,

    their contribution to aggregate productivity growth was the same.

    Unfortunately, the growth in Korea’s manufacturing productivity is on a downward spiral, and the diminishing productivity growth of young plants, in particular, is a major factor.

    To identify the sectors that are facing lower productivity growth, plants were classified according to their technology intensity.

    It was found that, in the past 3 years,
    young plants in the high-tech group had the fastest decline in
    productivity growth.

    Then, why is the productivity growth of young plants continuing to decline?

    When the average productivity of old plants over 11 years was set at 100,
    the analysis revealed that the average productivity of young plants had, in fact, increased,

    but, their share of value-added declined.

    The sluggish entry and growth of young plants has
    reduced their share of the value-added, particularly those that
    have been in operation for 3 to 5 years.

    The decline in the share of value added of highly productive
    young plants implies that resources are being inefficiently allocated to plants with low productivity.

    And, it has become difficult to establish and grow in manufacturing in Korea’s economic environment.

    Then, what is needed to promote the growth of young plants?

    (Interview with the author)
    Because the entry and growth of young firms affect future growth, we need to examine whether the current government entrepreneurship programs are providing practical support.

    When we consider that innovative and high-growth firms lead economic growth, programs must focus on promoting growth and driving innovation of young firms.

    The selection process of innovative firms should shift away from being government-certified. Instead, the criteria for young innovative firms should involve private sector investment. Young innovative firms can refer to firms under a certain age who received investments from venture capital or those whose R&D investment ratio exceeds a certain level.

    However, this does not mean that it is effective for the government to select and support. Rather, it should focus its capabilities on reforming regulations that hinder the establishment and growth of innovative firms.
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    Can most people be trusted?

    Social capital is an intangible asset that is formed through relationships between people and includes trust, networks and norms.

    It is essential to economic growth and structural reform as well as to the happiness of individuals and local communities.

    According to an international survey,
    Korea’s social capital, which was measured by the trust in others, has dropped far below that of advanced countries.

    As a result, competition has taken over cooperation and a
    ‘each to his own“ mentality now dominates Korean society.

    In fact, a survey conducted on the university students of four countries in 2017 found that 81% of Korean respondents thought high school was a ‘battlefield.“

    Social trust increases in line with the amount of education received.
    But, while this is very true for countries in Northern Europe,
    it does not apply to those in the Eastern part of the continent and Korea.

    Then, what is the cause for the imbalance?

    Past studies found that the formation of social capital is more contingent on teaching methods than on education level.

    This is proven by the high levels of social capital in Northen Europe
    where horizontal teaching methods are actively practiced and
    the low levels in Eastern Europe and Korea where vertical teaching
    methods prevail.

    Then, can Korea really increase its social capital by changing its teaching methods?

    In order to find out, an educational experiment was conducted on
    the students of Gwangju Institute of Science and Technology for one
    semester.

    Three classes were taught via vertical methods centered around lectures and three via horizontal methods that adopted team-based discussions and projects. The changes in the students’ network of friends and perceptions of social capital were then tracked.

    The results revealed that students who were taught by horizontal methods had wider and tighter networks of friends.

    Also, horizontal classes helped to ease any imbalances within the students’ networks so that friendships were not overly dependent on a few specific students.

    Horizontal classes made bigger improvements in the students’ perceptions about social capital, including trust, fairness and compliance.

    And, the more team discussions and projects were undertaken, the more inclusive the classes became.

    How were these improvements possible when the subjects did not deal with social capital?

    Horizontal teaching methods encourage interaction and collaboration which, in turn, expands students’ networks and enhances their perceptions about social capital.

    [Interview with the author]
    Schools provide a venue for proper social relationships to be formed. They are also a place to cultivate social capital which includes trust and teamwork and public and law-abiding spirit. However, due to a fiercely competitive environment, we are taught how to keep others at bay and self-cultivate rather than to respect them and work together.
    The level of social capital that is fostered through education in Korea is low. As such, teaching methods need to be reformed. Transforming classes to be horizontal and participatory will not only boost Korea’s social capital but also foster “cooperative geeks” who will be much needed during the fourth industrial revolution.
    We live in an era where lectures by renowned lecturers and professors are readily available via the Internet. However, if schools continue to provide students with one-sided, lecture-oriented education, answers will be needed as to why children are forced into schools in the first place.
    In order to be successful at innovative education, we should reform evaluation systems and create an environment that enables teachers to concentrate on their classes. Also, a social consensus must be formed to enable educators at all stages to lead the innovation in education.
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    The objective of a minimum wage system is to guarantee a stable income level for workers.

    The Korean government has made consistent efforts to raise the minimum wage.
    In 2018, it has increased the wage by a large margin with a goal to achieve the 10 thousand won mark by 2020.

    So what would be the consequences of such a sharp increase?

    A higher minimum wage pushes up not only wages at the bottom but also those near the bottom, narrowing the wage gap and improving income distribution.

    During the last five years, Korea has seen a gradual increase in the minimum wage and a narrowing of income disparity as wages at the bottom are pushed up with the minimum wage increase.

    On the other hand, higher wages mean higher costs for business owners.

    In response to minimum wage increases, businesses may raise product prices or reduce working hours or cut benefits.
    If wages continue to increase and the cost rise becomes unbearable, businesses will reduce their employees.

    Then, will an increase in the minimum wage actually lead to job losses in the future?

    KDI examined the anticipated job losses inferring from economic theories and experiences from overseas.

    In the U.S, a 10% rise in the minimum wage generally resulted in a modest 0.15% job decrease.

    But the minimum wage is higher in Korea than in the U.S.
    as a ratio to the median wage.
    Consequently, the negative effect is likely to be larger in Korea.

    Hungary has raised its minimum wage by a surprising 60% during the four years since 2000.
    The result was a large decrease of jobs, as much as 2% of total number of jobs.

    In France, the minimum wage is set as high as 61% of the median wage.
    In this case, wages are leveled out, and workers experience no wage rise in their first 10 years of career, weakening their work incentives.

    Korea’s minimum wage increased by 16.4% in 2018 from the previous year.

    If we apply the estimates from the U.S., the rise would involve a job loss of 36 thousand workers.
    If Hungary’s case is applied, the job loss would be 84 thousand workers.

    These figures correspond to 0.2 and 0.4% of total employment,
    and are not considered as big numbers.

    In fact, up to April, the employment statistics have not shown
    any significant decline of jobs among the youth under age 25
    or women in the fifties, who are the major minimum wage worker groups.

    Further, there is no clear evidence that wholesale and retail jobs
    and restaurants and lodging jobs have reduced due to the minimum wage increase.

    This could be owing to the government’s subsidies which has been provided to buffer the shocks.

    Then, what would happen if the minimum wage is to increase by 15% in 2019 and again in 2020?

    It is expected that workers affected by the minimum wage hike will increase from 8.7% in 2017 to 28% in 2020.

    Also, the minimum wage will reach 68% of the median wage by 2020.

    Indeed, if the impact from the minimum wage increase expands,
    businesses may have to cut down their labor significantly.

    An estimation of the job loss using Hungary’s example reveals that
    job loss figures would mark 84,000 in 2018, 96,000 in 2019, and 144,000 in 2020.

    These figures do not take the government’s wage subsidies
    and possible institutional changes into consideration,
    and the actual size of job loss may not be as pronounced as anticipated.

    [Interview with the author]
    Despite the existing concerns over a sharp rise in the minimum wage, up to now the minimum wage increase seems to be settling down with little side effects. The government seems to be succeeding in attaining its original goal of raising the income of low-wage workers.
    However, the impact of minimum wage increase depends upon how quickly it is increased and how large the size of the affected minimum wage workers is.
    In order to attain the 10,000 won mark by 2020, the minimum wage must be increased by 15% next year, which is 60% of the median wage. And a further rise would mean an even higher ratio. Then, this may result in a larger loss than the gain. As such, a slowdown in the speed of the minimum wag rise would be preferable in reaching a higher minimum wage level ultimately.
  • For more information
    The sharp downward trajectory in productivity since 2011
    has prompted many to voice their concerns over the slowdown in
    Korea’s economic growth.

    So, why is the productivity growth rate declining?

    To find out,
    an analysis was conducted on the growth in the aggregate
    productivity of Korean firms from 2006 to 2016
    based on the increase in average productivity, allocative efficiency,
    and the entry and exit effect.

    The results revealed that from 2011,
    allocative efficiency has rapidly fallen,
    which has, in turn, diminished overall productivity.

    A decline in allocative efficiency implies that resources are being
    excessively allocated to low-productivity firms while being inadequately
    allocated to high-productivity firms.

    Then, who has primarily contributed to the decline in
    allocative efficiency?

    The changes in allocative efficiency were decomposed into
    the contribution of stand-alone firms and
    that of the affiliates of large business groups designated by
    the Korea Fair trade Commission for limitations on cross-shareholding.

    A visible downturn was discovered in the allocative efficiency of
    large business-group firms from 2011,
    which has consequently curtailed the firms’ overall growth in aggregate
    productivity.

    On the other hand,
    no notable trends were found for stand-alone firms.

    Why is the decline mainly found in business-group firms?

    Compared to stand-alone firms,
    the increased output of business-group firms on an additional one unit
    of capital is lower.

    This is because the excessive amounts of capital used by business
    groups distort the allocation of resources,
    and not because their technological competence is inferior.

    Moreover,
    the market exit rate of large firms with over 300 employees
    depends on the ownership structure.

    Compared to stand-alone firms, business-group firms are less likely to
    exit and also show lower productivity at the point of exit.

    As a result,
    the prolonged presence of business-group firms with low capital
    productivity in the market is exacerbating the decline in allocative
    efficiency within the Korean economy.

    [저자 인터뷰]
    The problems associated with the economic concentration of business groups are vital not only in terms of fairness but also efficiency in the market economy and growth.

    This study shows that the recent slowdown in Korea’s economic growth can derive from the declining allocative efficiency brought about by business groups.

    Accordingly, the holding company system needs to be reorganized so that business-groups’ excessive capital holdings do not impede the growth of stand-alone firms and to reverse the decline in allocative efficiency. Also, measures should be established to prevent the misconduct of controlling shareholders from leading to the misallocation of resources.
  • For more information
    Qualcomm, Symantec, 23andMe and iRobot,
    are all firms that started small but are now market leaders
    thanks to their innovative technological capabilities.

    And, supporting their growth was the US’ Small Business Innovation
    Research program, or SBIR, which provides active R&D support to small
    companies and startups.

    Taking cue from the US’ program,
    the Korean government established the Korea Small Business Innovation
    Research program in 1998 to drive the growth of Korea’s SMEs.

    Since then, the budget for the R&D grant has continued to mount,
    nearing the 3 trillion won mark in 2015.

    Korea is now ahead of Germany and Japan,
    and is the second largest spender after the US.

    Thanks to the grants,
    many of the recipients have been able to strengthen their technological
    capabilities.

    However, due to the lack of preceding research,
    it is unclear what other benefits the grants offer.

    Accordingly, KDI analyzed the economic gains of Korea’s R&D support.

    A simple comparison was first conducted between recipients and
    non-recipients based on ten performance indicators.

    The results found that recipients overwhelmed their counterparts
    in terms of operating performance, financing and capabilities and assets
    at the time of support.

    But, after 2 or 3 years, the trend reverses,
    with non-recipients making bigger improvements across the majority of
    indicators.

    Next, an examination was conducted on
    the impact of the grant on corporate growth.

    The grants enabled companies to secure more funding
    and expand their investments in all aspects.

    Unfortunately, this failed to improve the value added,
    operating profit and sales.

    Then, why is the government grant unable to help with the
    corporate value added?

    Believing that technological competence generates high growth,
    the government selects recipients based on this.

    In fact, compared to the small number of companies with a large
    number of registered patents, a relatively large share were selected as
    recipients, and vice versa.

    And, contrary to expectations,
    the average value added of those with many patents was lower.

    In addition, the value added of numerous recipients showed an
    improvement while that of the majority declined.

    Those in the lowest decile, in particular, had long histories, large-scale
    capital and numerous patent registrations.

    As such,
    using a predictive model that is more focused on economic performance
    than technological competence to select recipients and distribute grants
    could double the value added.

    [저자 인터뷰]
    Until now, the selection and planning processes for
    the government’s SME R&D support program
    have been overly dependent on technology experts.
    As a result, a mismatch has ensued in which
    firms with rich R&D experience become recipients
    while those at the seed stage receive policy financing.
    In order to maximize the creation of value added,
    the R&D grant must maintain the role of a seed fund
    and focus on supporting underfunded, small businesses
    with high-risk research and development.
    If a predictive model for the policy effects was to be developed
    and applied to the recipient selection process,
    the government will be able to break away from
    the current complicated system
    and turn its attention to supporting the structured research of SMEs.
  • For more information
    For one semester in middle school, the free learning semester, or FLS,
    eliminates tests and exams, cuts back on academic subjects,
    and introduces diverse interactive programs.

    The goal is to liberate students from the burden of exams and grades
    and allow them to explore their options and future career paths
    as well as further develop their creativity and social skills.

    The response has been highly positive thus far.

    However, having no exams for a whole semester,
    many have come to regard the FLS
    as a chance to focus on their advance learning,
    raising concerns that it is encouraging the demand for private tutoring.

    So, is this true?

    Using Statistics Korea’s Private Tutoring Expenditure Survey,
    KDI analyzed the impact of the FLS on private tutoring.

    Overall, although no significant changes were observed,
    discrepancies were found between different income levels.

    Indeed, there was an explicit increase in
    the participation in and expenditure on
    private tutoring among high-income households
    while no meaningful changes were found for
    middle to low income households, barring a slight decline.

    Then, has the private tutoring of students
    from high-income households really increased?

    An examination was first conducted to examine
    whether the rise in private tutoring
    during the implementation of the FLS was a mere coincidence,
    and whether the increase was driven by other factors.

    To rule out the connection between
    the timing of the FLS and increase in private tutoring,
    the effects of the FLS on the previous year’s trends in private tutoring
    were examined which revealed no relevant findings.

    This implied that the demand for private tutoring increased
    after the implementation of the FLS
    and not the other way round.

    Next, the same analysis was applied to high school students.

    This is because middle and high school students are
    similar in many aspects.
    As such, if there were any other driving factors aside from the FLS,
    similar results would be obtained for high school students
    who are irrelevant to the FLS.

    No meaningful results were found, however, implying that
    the increasing trend in private tutoring was
    most likely not driven by other factors.

    Finally, a comparison was made between
    different income levels in terms of participation.

    It was found that higher-income households sought private tutoring
    more for admissions and advance learning purposes
    while lower-income households found it was necessary for
    supplementary reasons.

    Consequently,
    having been freed from GPAs during the FLS,
    many of those who could afford it
    were increasing their expenditure on private tutoring,
    especially for advance learning.

    [Interview]

    If the Free Learning Semester does indeed prompt a rise in private-tutoring investment,
    mainly among the high-income group,
    it could inadvertently exacerbate the education gap
    between income groups even further.

    As such, efforts must be made to qualitatively enhance academic courses
    before expanding the FLS to cover the whole year.
    This would greatly contribute to easing parental concerns.
    After-school programs must also be strengthened to assure students
    from low-income households with sufficient educational opportunities.

    Although the FLS is a well-intended policy,
    careful consideration must be given to the fact that
    the resulting reduction in public education could widen the gap between the classes.
  • For more information
    Many countries around the globe have embraced work-family balance policies
    to bolster the fertility rate and women’s participation in the labor market.

    Korea’s key work-family balance polices include maternity leave,
    parental leave and reduced working hours for childcare,
    which are provided to those who have been covered by employment insurance
    for over 6 months.

    The use of maternity leave in Korea is high,
    marking 84.6% of all health-insured employees in 2015.

    As for parental leave, the utilization rate is not as high.

    The government even provides special bonuses for men taking parental leave,
    wherein the father receives a higher pay rate
    when the leave is taken in succession to the mother.

    However, only 13.4% of parental leave takers are men.

    And, despite the fact Korea provides the longest parental leave for men
    within the OECD,
    the income replacement ratio remains at a low 32.8%.

    Additionally, those reducing their working hours for childcare
    totaled a mere 3% or 2,761 of parental leave takers in 2016.

    Meanwhile, government subsidies are offered to companies
    that offer work-family balance programs.
    But, awareness of such provisions is still very limited.

    Then, how does work-family balance policies affect
    women’s continued participation
    in the labor market and childbirth?

    According to KDI analysis,
    the provision of maternity leave contributes to the fertility rate
    while parental leave enables women to continue with their economic activities.

    Specifically,
    part-time workers are less likely to continue working than full-time workers,
    and only when the part-time employment is voluntary does the fertility rate increase.

    Next, a review was conducted on the correlation between men’s contribution
    in the home and women’s continued economic activities.

    It was revealed that despite the decline in the total number of housework hours
    in dual-income households during the past decade,
    more than 80% of the housework is still done by women.

    Also, women are 3.5%p more likely to continue their economic activities
    if the men’s contribution in the home increases 50%p
    in the couple’s total housework hours.

    As such,
    in order to improve Korea’s fertility rate and women’s participation in the labor market,
    measures should be sought to improve the accessibility of work-family balance programs
    and men’s participation in the home.

    [Interview]
    The coverage rate of employment insurance for women must be expanded
    as the relevant pay under work-family balance policies are
    only offered to those who are insured.

    Meanwhile, there are also cases wherein the programs are not utilized
    even though the workers are insured.

    As such, work-family programs should be further promoted and
    labor consultation services provided to resolve problems and
    difficulties in utilizing the programs.

    Additionally, a strict monitoring of companies
    that are suspected of noncompliance is needed.
    Indeed, more female workers would be able to benefit
    if there was a stricter management of companies with poor performance
    in the provision of programs
    using the National Health and Employment Insurance Service database.

    And, in order to improve employers’ perceptions
    about work-family balance policies,
    the government must enhance its promotional efforts
    about the available subsidies and support.
    Also, consultation services should be provided to employers
    to educate them on assigning tasks and distributing gains
    as well as employing replacement employees.

    Finally, to enhance men’s participation in the home,
    measures such as bonuses for men’s parental leave and
    increasing the income replacement ratio of
    those taking shorter parental leave should be considered.