State Intervention Can Cut Inequality, But the Current Approach Is Wrong

from The Debate: Income and Wealth Inequality in South Korea: Government-led or Market-led Solutions?Global Asia (March 2019, vol. 14, no. 1)

South Korea’s per capita gross domestic product surpassed US$30,000 in 2018, making the country the seventh member of the so-called “30-50 club” — economies with US$30,000 in per capita GDP and a population of 50 million people or more. However, news of this remarkable achievement of a once-poor nation has been overshadowed by the uneasy revelation of a widening income gap between poor and rich households. During the last year, the average household income for the bottom fifth of the population fell by 17.7 percent, while that for the top fifth increased by 10.4 percent. However, the redistributive role of the welfare state was minimal. In particular, the amount of public transfers to the first quintile (or bottom fifth) increased only by 17.1 percent, while that to the fifth quintile (or top fifth) increased by 53.5 percent. As a result, the ratio of disposable income of the top quintile to that of the bottom quintile rose from 5.44 to 7.36. It’s time for the South Korean government to substantially increase redistribution through taxes and transfers.

Before we discuss the role of government in addressing growing inequality, we need to know the long-term trend of inequality and the causes behind it. Inequality in South Korea fell dramatically during the first few decades after liberation from Japanese rule. Low inequality was maintained during the period of rapid industrialization until the early or mid-1990s. The top 1 percent’s share of national income fell from around 20 percent during the 1930s and early 1940s to around 7 percent from the late 1970s to the mid-1990s (precise data were missing for the period from the mid-1940s to mid-1990s). Then, it began to rise, surpassing 12 percent in the 2010s. What enabled South Korea to enjoy a reputation for “growth with equity” during the period of rapid industrialization? Why has the country been experiencing increasing inequality since the late 1990s? Why has inequality been increasing further despite the efforts of the current government of President Moon Jae-in to reduce income inequality through its strategy of “income-led growth?”

The extremely high levels of inequality in income and wealth during the colonial era were lowered by sweeping land reform, which was implemented by the American military government in 1948 to redistribute Japanese-held land and by the South Korean government in 1950 to redistribute land held by Korean landlords. Before export-led industrialization took off during the 1960s, the country was already enjoying very favorable conditions for economic development, such as a low level of inequality and rapid expansion of education. The provision of abundant and cheap labor with literacy and numeracy propelled industrialization, which in turn helped to maintain near-full employment by absorbing rural migrants into urban areas. Although President Park Chung-hee’s chaebol-centered strategy led to increasing economic concentration over time, near-full employment and a low level of wage gaps under the state’s repression of the labor movement helped to maintain a low level of income inequality. During this period, social welfare expenditures were minimal, because the priority in the budget was economic growth under the principle of “growth first, redistribution later.” Thus, neither market forces nor the redistributive role of the welfare state was responsible for South Korea’s low level of inequality. The foundation for remarkable “growth with equity” was laid by land reform, with full employment and low wage disparity helping to curb the rise of income inequality.

However, increasing economic concentration by chaebols — South Korea’s large family-owned conglomerates — inevitably brought about widening gaps between large firms and small firms, as well as between the wealthy and the poor. Market forces played a role in increasing inequality, with the gradual liberalization of trade and markets that started in the 1980s and accelerated in the 1990s. Globalization further strengthened this trend. While South Korea’s top chaebols have now become leading global firms, the trickle-down effect disappeared, because their growth was not accompanied by an expansion in domestic employment.

In addition, democratization did not do much to address the problem of increasing inequality. It is commonly recognized that democratic politics tends to contribute to reducing inequality through redistributive policies, while market forces tend to increase inequality. To a certain extent, democratic politics helped to expand the welfare state, and social welfare expenditures have increased steadily. However, the ratio of social welfare spending to GDP in South Korea is still only half the OECD average, and the redistributive role of the country’s welfare state is still minimal. Moreover, democratization helped to increase inequality in some ways. Wage gaps have increased in the dual labor markets. Organized labor concentrated in the regular workforce in large firms has been able to experience rapidly rising wages, while most of the non-regular workers in small firms are not organized. Also, democratic politics helped to reduce taxes on the rich. Top marginal income tax rates plummeted from a high of 70 percent during the 1970s to 40 percent in 1994 and 35 percent in 2004. The rate has increased slightly since then, reaching 42 percent in 2018. Corporate income taxes have also been lowered, and taxes on capital gains and capital income are still minimal. Numerous tax exemptions benefit the rich and large firms. It seems that policy-making is largely captured by the chaebols and the rich.

President Moon, who was inaugurated in May 2017, declared a strategy of “income-led growth” or “inclusive growth,” stressing the need to help the poor and reduce inequality. His signature policy was a rapid rise in the minimum wage. The minimum wage increase apparently has not produced the intended result of increased incomes for the poor. Household income, including earned income, rose for the rich but plummeted for the poor, widening the income gap. In the meantime, the redistributive role of the welfare state has not increased. The government should not scrap the strategy of inclusive growth, but it should seriously reconsider a policy package that has gone too far in raising minimum wages and done too little to increase redistribution of income through taxes and transfers.