South Korea’s economy threatens to look like Japan’s
IN 1989, AT At the height of Japan’s economic and financial heyday, few dared to suggest that the country might one day be supplanted as Asia’s wealthiest major nation. Per person, South Korea wasn’t even half as rich. But then, powerful stock and property bubbles burst in Tokyo, triggering several “lost” decades for the Land of the Rising Sun. Meanwhile, the South Korean economy boomed. In 2018, his GDP per person, adjusted for purchasing power, exceeds that of Japan.
The similarities between the two economies go beyond the convergence of income levels. Both built their wealth during periods of export-led growth. Today, South Korea’s working-age population is shrinking, like Japan’s after the mid-1990s. Stranger are the echoes between the financial risks that emerged in Japan in the late 1980s and those riding in South Korea today. They too could trap Asia’s mightiest tiger in the doldrums for decades.
Expensive homes have become a major issue in South Korea’s tight presidential election on March 9. The two frontrunners – Lee Jae-myung of the ruling Minjoo party and Yoon Seok-youl of the center-right People Power party – have clashed over housing policy throughout the campaign.
Repeated efforts by the outgoing government to rein in the property market, through tighter loan-to-value restrictions on mortgages and higher taxes for owners of multiple dwellings, had little effect. Low interest rates and an aging population seeking rental income as retirement approaches have proven to be stronger forces. In the Seoul metropolitan area, home to about half of South Korea’s 52 million people, house prices have nearly doubled in the past decade.
There is no specific threshold beyond which the value of all land in a country, relative to the size of its economy, suggests that asset prices are unsustainable. But the ratio for South Korea is both high by international standards and relative to the country’s recent history. It now operates at five times its GDPcompared to about four times in 2013. At the height of the Japanese madness, the value of all land rose to 5.4 times GDPbefore collapsing in the 1990s.
Deepening South Korea’s apparent bubble would be less dangerous if liabilities had not risen in line with asset values. South Korean people and businesses have been borrowing at a breakneck pace. In September last year, the country’s household debt stood at 107% of its GDP, compared to 58% in Germany and 79% in America. Non-financial corporate debt reached 114%, above the average for advanced economies.
This too is reminiscent of 1980s Japan, and not in a good way. Richard Koo of the Nomura Research Institute in Tokyo warns of a possible “balance sheet recession”. During Japan’s boom years, the values of assets and liabilities jumped together. When its property and stock market bubble burst, asset values plummeted, but borrowers still had the same debts to repay. This left them in a state of negative equity. As businesses and households all rushed to deleverage, the economy contracted. “Individually, they did the right thing. Collectively they were destroying the economy,” says Mr. Koo.
In 2020 the IMF signaled that South Korea was one crash away from a damaging balance sheet recession. Although lending to subprime borrowers is limited, he noted that about half of credit to South Korean households was either tied to floating interest rates or required large lump-sum repayments, meaning it should be refinanced at potentially higher interest rates. He also noted that the country’s many small and medium-sized businesses, dependent on short-term bank loans secured by real estate collateral, appeared exposed.
Has the dreaded accident happened? South Korea was one of the first major economies to raise interest rates during the pandemic, and has now done so three times. Most analysts expect the tightening to continue: the central bank has expressed concern about both rising inflation and the risk to financial stability posed by soaring asset values. Again, this has a flavor of the 1980s: Japan’s troubles began when the central bank began to rapidly raise rates to burst the country’s asset bubble.
The Bank of Korea’s policy of “leaning against the wind,” as Nomura’s Jeong Woo Park calls it, has ripple effects that can be hard to stop. Due to tighter credit controls introduced to cool property prices, mortgage interest rates are accelerating faster than benchmark rates. After hitting pre-pandemic levels, they flirted with decade highs in January.
The parallel has limits. Japan’s financial institutions were notoriously poorly regulated, leaving policymakers constantly amazed at the extent of the damage done to the financial system as crises erupted repeatedly during the 1990s. South Korea’s Unusual Jeonse Credit System , through which households borrow to finance flat-rate rents, makes it difficult to assess the real risk of household debt.
But the frightening similarities will continue to grow as South Korean politicians, central bankers and regulators scramble to bring the asset price boom to a smooth end. They have the Japanese experience to learn. But understanding the worst-case scenario may be easier than avoiding it. ■
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This article appeared in the Finance and Economics section of the print edition under the title “Kindred Seoul”