The Peninsula

The Hidden Costs of President Moon’s Minimum Wage Policy

By Hayeon Carol Park

In July 2017, South Korea’s Minimum Wage Commission finalized the decision to increase the country’s minimum wage by 16 percent to 7,530 won ($6.60) per hour in 2018. This minimum wage hike is seen as an early victory for President Moon Jae-in, who has pledged to be a “jobs president” by raising the minimum wage to 10,000 ($8.80) won by 2020. Ironically, in the weeks following the decision, Gallup Korea’s survey of 1,012 adults across the country showed that President Moon’s approval rating dropped by 6 percentage points. Such a dramatic increase in minimum wages, the biggest since 2001, may have played a prominent role in reducing President Moon’s popularity. Further, as some experts and small business owners argue, sudden minimum wage hikes can negatively impact Korea’s economy.

President Moon pushed for a steep increase in the minimum wage as a key ingredient of his income-led growth policy. In contrast to his two predecessors, who argued that businesses must grow first for jobs to be created, President Moon assumes that rising income and boosting consumption can bring growth and lift people out of poverty. To meet Moon’s 10,000 won goal, the minimum wage needs to keep increasing by about 15 percent annually, compared with an average of 7.4 percent over the last five years. But according to Dr. Bong Young-Shik from Yonsei University, increasing labor costs that quickly is sure to hurt small and medium-sized enterprises (SMEs).

There are three main mechanisms that make such a quick minimum wage hike detrimental to the Korean economy. First of all, it could trigger a higher unemployment rate. According to the Korea Federation of SMEs, additional labor costs are estimated to reach 81.5 trillion won if the minimum wage rises to 10,000 won. Going further, a 2016 study of Korea’s labor market by Lee Jung-min, professor of economics at Seoul National University, predicts that a 0.1 percentage point increase in the minimum wage would result in a 0.15 percentage point reduction in jobs, due to lower profitability and lay-offs. As such, the net wages earned by workers in the Korean economy is projected to begin falling when minimum wage rise exceeds 10 percent. This prediction is exacerbated by the fact that most minimum wage employees tend to work at SMEs, including family-owned convenience stores and coffee shops.

Secondly, a minimum wage hike can contribute to South Korea’s fiscal deficit. The finance ministry proved this point when it announced its plan to spend $2.66 billion to assist any SMEs that are negatively affected by the new wage policy. In addition, higher unemployment due to the closure of smaller businesses will compel more people to rely on government handouts. “[This plan] would obviously come at a high financial cost that would bring Korea deep into a fiscal deficit and add to the public debt that has doubled to nearly 40 percent since 2000,” said Hosuk Lee-Makiyama, a director at the European Centre for International Political Economy. Furthermore, the 2016 OECD study of South Korea recommended that instead of providing large subsidies to the SMEs, the Korean government should encourage the SMEs to compete and innovate.

The third issue with the plan involves the potential polarization of the economy. Dr. Yoon Chang-hyun, a professor of finance at the University of Seoul, worries that the higher minimum wage will induce further polarization of the labor market – narrowing the door to job-seekers while only bringing higher wages and security to the already employed. Businesses will also experience polarization. Large companies can absorb higher wage rates into their production costs and still maintain high enough profits. Smaller shops, on the other hand, will have no choice but to lay off workers or go out of business.

In the end, the economic costs of President Moon’s minimum wage policy must be compared to the corresponding social benefits. As this 2016 KEI blog on the minimum wage recognized, the wage level in Korea has not kept up with the rise of Seoul’s living costs, leaving many families unable to sustain a healthy lifestyle. These social dimensions must not be ignored. Hence, a balance must be found by recognizing that the minimum wage needs to be raised, but in a more cautious way that is carefully calculated to minimize the adverse effects.

Korean government data from 1988 and 2013 showed that annual growth rates were usually lower when the ratio of minimum wage to average income was higher. Based on this statistic, the pace of minimum wage increases should be adjusted slowly and with flexibility, taking into account variables like unemployment, prices, and living costs. In addition, policymakers should consider differentiating minimum wage levels among different industrial sectors of Korea’s economy or easing regulations for SMEs so that these businesses can thrive and afford to hire more workers. Exploring these options will hopefully bring us closer to finding a compromise between underpaid workers and profit-seeking SME owners.

Hayeon Carol Park graduated from Yale University with a Master’s degree in International and Development Economics. The views expressed here are the author’s alone.

Image from gorekun’s photostream on flickr Creative Commons.