## wp17260

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**Canonical URL:** [wp17260](https://www.imf.org/-/media/files/publications/wp/2017/wp17260.pdf)

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---

### Key findings
- Korea’s economic growth has been slowing since the 2000s; contributing factors cited include demographic headwinds, growth convergence, and the post-crisis global recession.
- A myriad of regulations, often motivated by social concerns about income inequality, have deterred innovations and productive investments.
- Labor market rigidities—particularly pronounced among large firms—and dualities have impeded corporate sector restructuring; some corporate losses have been socialized at the expense of taxpayers.
- The economy has become polarized across sectors and regions with increasingly uneven income distributions, undermining social cohesion.

### Structural constraints and demographic outlook
- Labor market rigidities and dualities are emphasized as impediments to corporate restructuring and productivity; regulatory burdens deter innovation and investment.
- Korea is expected to face stronger headwinds from a shrinking and aging population; text projects Korea will become the second oldest country in the world by 2060, "only next to Qatar".
- Population is noted as beginning to shrink (phrase present in source).

### Growth accounting, firm performance, and inequality (selected indicators and exact values)
- Growth accounting for Korea, 2001–15 (in percent):
  - 2001–05: Real GDP 4.7; Capital 2.1; Labor 1.0; TFP 1.5
  - 2006–10: Real GDP 4.1; Capital 1.8; Labor 0.5; TFP 1.8
  - 2011–15: Real GDP 3.0; Capital 1.4; Labor 1.0; TFP 0.5
- Age and demographics:
  - The elderly are projected to account for 20 percent of Korea’s total population in less than a decade.
  - Average age of the bottom 10 percent rose from 39 years in 1990 to 65.3 years by 2016.
  - Korea has the highest elderly poverty rate among OECD countries (relative ranking described).
- Firm performance and misallocation:
  - Corporate revenue growth declined to 0–5 percent by 2015 from 15–20 percent in the early 1990s (large sample of externally-audited firms).
  - Operational profit ratio fell from about 6 percent to 4 percent.
  - Zombie firms (interest coverage ratio <1 for three consecutive years) accounted for 13 percent of all firms as of 2016; 9 percent in manufacturing; 17 percent in services.
- Income distribution:
  - Labor income growth has fallen relative to profits since the mid-1990s; bottom 10 percent experienced virtually no income growth while top 10 percent experienced about 6 per cent per annum.
  - Income share of the top 10 percent rose from less than 30 percent in the 1970s to 45 percent by 2013.

### Proposed operational framework: simultaneous economic freedom and social protection
- Core objective: simultaneous big push for greater economic freedom (structural reforms) and stronger social protection, within long-run fiscal sustainability parameters.
- Rationale:
  - Schumpeterian view: economic freedom to work and invest promotes productivity via innovation and creative destruction.
  - Inclusive growth is a social choice given Korea’s legacy of unbalanced growth and societal preference for inclusiveness.
  - Empirical summary: tradeoffs between redistribution and growth may be less severe; lower net inequality after taxes and transfers is robustly correlated with faster and more durable growth (Ostry et al., 2014).
- Political economy constraint:
  - Past failure attributed to social divide on whether structural reforms worsen inequality and whether redistribution harms growth; framework aims to be economically sustainable and politically viable by communicating welfare contributions and enabling bargaining.

### Structural reforms recommended (detailed measures preserved)
- Labor market reforms (three legs: employer flexibility, active labor policies, worker social protection):
  - Amend the Labor Standards Act (LSA): allow layoffs based on good faith and transparent managerial decisions while penalizing unfair labor practices; burden of proof in disputes on management; shorten consultation period before layoffs from 50 business days to 30 business days.
  - Institutionalize flexible labor contracts and prohibit unjustified discrimination against temporary workers; reform mandatory conversion of temporary to permanent employment (current two-year rule).
  - Incentivize active job training and job search: structure unemployment insurance to provide larger and longer benefits to those more active in training and search; establish central-local policy network to share job information and minimize duplication.
- Financial sector reforms:
  - Convert financial business regulations into a negative system (institutions can operate unless restricted), paired with upgraded prudential regulation and supervision; adopt a gradual approach.
  - Improve access to long-term financing for SMEs: short-term borrowing is about 70 percent of total borrowing by SMEs versus the OECD average of 46 percent.
  - Specific measures:
    - Refocus Korea Development Bank (KDB): increase balance sheet exposure to venture businesses from current 7 percent to 30 percent; restructure governance to separate venture investment decisions from directed lending.
    - Provide low cost matching funds earmarked for lending to SMEs and start-ups at maturities of three years or longer, and share losses from non-performing loans.
    - Broaden eligible collateral menu: develop statistical framework to assess collateral value of movable assets and property rights owned by SMEs; consider establishing a public agency to lead evaluation.
    - Lower bar for equity financing for venture firms: reduce KOSDAQ listing thresholds from current 30 billion won and 3 billion won to 25 billion won and 1.5 billion won, respectively.
  - Caution: too-drastic deregulation risks worsening SME access until banks develop sophisticated data-based lending and venture capital markets deepen; targeted government support and incentives recommended in interim.
- Other reforms:
  - Deregulate business investment in real estate in the Seoul metropolitan area; address regional imbalances via fiscal transfers rather than geography-based business location restrictions.
  - Further liberalize immigration and foreign direct investment.
  - Strengthen surveillance and enforcement against unfair business practices alongside deregulation.

### Social protection package: measures, projections, and precise fiscal estimates
- Policy intent: make economic freedom affordable by cushioning risks from creative destruction and enabling investment in human capital.
- Unemployment benefits — proposed measures:
  - Increase replacement ratio from 60 percent to 80 percent in two steps; immediate increase to 70 percent would be just sufficient to cover minimum cost of living for a head of household with three dependents.
  - Extend maximum payment duration to 18 months; expected to increase average payment duration to eight months, up from three months.
  - Front load disbursement using contingent allowances: currently about 4½ percent of total disbursements; can be increased to 8 percent by 2025.
  - Make coverage universal; level of assistance set to make up for difference between uninsured worker household income during unemployment and minimum cost of living.
- Unemployment spending needs and labor market projections:
  - Labor market reforms, if fully implemented, are estimated to increase the unemployment rate from 3 percent to 7 percent in the short run before bringing it back to 3 percent in the medium term (Byeon, 2017).
  - Unemployment rate for youth is projected to rise to 12–13 percent temporarily before stabilizing at 6 to 7 percent.
  - Total spending need for proposed unemployment measures: about 125 trillion won in total over 2018–22.
- Stabilizing cost of living for low-income households — proposed measures and costs:
  - Public rental housing: increase share of households in public rental units to 20 percent by 2022.
    - Existing stock: 1.2 million units as of 2017.
    - Additional supply needed: 2.9 million units via 1.7 million "build and rent", 0.35 million "buy and rent", 0.85 million "lease and rent".
    - Supplying additional 2.9 million units would cost 331 trillion won over 2018–22: 233 trillion won for "build and rent", 33 trillion won for "buy and rent", 65 trillion won for "lease and rent".
    - Out of 331 trillion won, 221 trillion won can be covered by existing public housing investment fund and Korea Land and Housing Corporation.
    - Net fiscal cost to the central government: 110 trillion won over 2018–22.
  - Child allowances:
    - 200,000 won per month for a child aged 4 or less.
    - 100,000 won per month for a child aged 5 to 9.
    - Net fiscal cost estimated at about 39 trillion won over 2018–22 (reflects savings from abolishing existing family care allowances and child care subsidies).
  - Education:
    - Provide high school education free for all: expected cost 4 trillion won over 2018–22.
    - Net cost of subsidizing college education: 14–15 trillion won over 2018–22.
- Aggregate social protection spending needs:
  - Total spending needs associated with proposed social protection measures: 293 trillion won over 2018–22, or 4 percent of annual GDP.
  - About two thirds of total spending need (excluding spending for public housing) are permanent in nature.
  - Given magnitude and permanence, funding should come primarily from permanent expenditure restructuring and tax increases.

### Funding plan: expenditure restructuring and tax measures (precise items and amounts)
- Expenditure restructuring — proposed savings (2018–22 totals and annual profiles as provided)
  - Restructure Employment Protection Fund and related measures: expected savings 13 trillion won.
  - Restructure social welfare budget, enforce contributions, raise retirement age: expected savings 16–17 trillion won.
  - Cut and rationalize public R&D investment (focus on basic research): expected savings 48 trillion won.
  - Rationalize public investment and job programs: expected yield 21.7 trillion won for 5 years; consolidation into employment insurance fund and unemployment benefits can save 15.5 trillion won; reduce job-search incentive program budget to save 6.2 trillion won.
  - Reduce duplication in age/fertility related spending: expected savings 7 trillion won over 2018–22.
  - Rationalize lending to SMEs and start-ups: expected savings 4–5 trillion won.
  - Table subtotals (Expenditure Restructuring): annual values 2018: 23.6; 2019: 25.0; 2020: 26.2; 2021: 27.7; 2022: 29.6; Total: 127.1 (trillion won).
- Taxes and tax expenditures — proposed revenue increases
  - Proposed increase in tax revenue of 107 trillion won over 2018–22 by raising tax rates.
  - Byeon (2017) proposal: increase VAT from current 10 percent to 15 percent in two steps during 2018–22.
  - Personal income tax reforms: raise tax rates for highest brackets, shift to total income taxation; expected revenue gain 14–15 trillion won.
  - Coal consumption tax: increase from 33 won/kg to 47 won/kg; expected revenue gain 6 trillion won.
  - Reduce and streamline tax exemptions: expected savings on tax expenditures 17–18 trillion won.
  - Table subtotals (Taxes and Tax Expenditures): annual values 2018: 17.4; 2019: 17.0; 2020: 33.2; 2021: 34.1; 2022: 43.2; Total: 144.8 (trillion won).
- Divestment in SOEs:
  - Proposal to sell 49 percent of government shares of six fully-owned, unlisted SOEs with book value 85 trillion won; assumed proceeds more than 27 trillion won (assumes market value 65 percent of book value).
  - Table entry: Divestment in SOEs total 27.0 (trillion won).
- Total funding profile in table (annual and total, in trillion won):
  - 2018: 41.0; 2019: 69.0; 2020: 59.4; 2021: 61.8; 2022: 72.8; Total: 298.9

### Fiscal implications, debt dynamics, and sensitivity (equations and numeric example preserved)
- Core financing approach: permanent increase in spending to be met by expenditure restructuring and tax increases; under this approach public debt dynamics and long-run fiscal sustainability are left little changed relative to status quo.
- Debt dynamics equations (as presented in source):
  - ∆dt+1 = ( (rt − gt+1) / (1+gt+1) ) dt − st+1
  - Long-run equilibrium debt ratio: d* = ( (1+g) / (r−g) ) s
  - Change in primary balance needed after a permanent one-percentage point increase in growth: −∆s = ( d* (1+g)^2 ) [ (1+r) − (1+g) ∂r/∂g ] ∆g
  - For small open economy where ∂r/∂g ≈ 0: −∆s ≈ A ∙ ∆g, A = [ (1+r) / (1+g)^2 ] d*
- Numeric example from source (parameters and results preserved):
  - Assumptions: g = 0.025, r = 0.03, and d* = 2.0 under the status quo scenario.
  - Result: a permanent ¼ percentage point increase in the growth rate of real GDP from structural reforms would allow the primary balance to be one half percentage points lower while keeping the debt limit unchanged.
  - Fiscal scaling implication: the required increase in tax revenue in the financing plan could be scaled down by about 7 trillion won per year without affecting the fiscal space available under the status quo scenario.
- Caveats:
  - Scope for debt financing depends on d*, r, g, and the growth delivered by reforms; negatively affected by sensitivity of r to g.

### Implementation, sequencing, and political economy guidance
- Recommended simultaneous package: big push for structural reforms to enhance economic freedom and expanded social protection to gain economic and political support.
- Sequencing and flexibility:
  - Exercise flexibility in pace and sequencing of spending and tax increases depending on macro conditions and reform progress.
  - Example: implement spending increases in multiple phases starting from expansion of unemployment benefits; institute tax increases in steps rather than at once.
- Risks and operational challenges:
  - Proposed increase in social protection over next five years is ambitious and may require extraordinary policy efforts to minimize waste and distortions.
  - Revenue shortfalls or delayed growth dividends could necessitate pacing adjustments.
- Favorable timing factors cited:
  - Growth dividends from reforms are likely larger when starting from a low growth rate.
  - Low inflation environment reduces near-term inflationary risk.
  - Low global interest rates would enable low-cost government borrowing if debt financing is needed.
  - Public finances described as "still very sound, with low debt."

*Source: IMF Working Paper wp17260 (selected sections provided).*

### 1. Labor Market Reforms ................................................................................................

### 1. Labor Market Reforms

### Key findings from the source text
- Korea’s economic growth has been slowing since the 2000s.
- Contributing factors cited include demographic headwinds, growth convergence, and the post-crisis global recession.
- A myriad of regulations, often motivated by social concerns about income inequality, have deterred innovations and productive investments.
- Labor market rigidities—particularly pronounced among large firms—and dualities have impeded corporate sector restructuring.
- Resulting corporate losses have in some cases been socialized at the expense of taxpayers.
- The economy has become polarized with diverging growth performances among sectors and regions, and with increasingly uneven income distributions, undermining social cohesion.

### Structural factors affecting labor markets
- Labor market rigidities and dualities are emphasized as impediments to corporate restructuring and productivity.
- Regulatory burdens, driven in part by social objectives, are identified as deterring innovation and productive investment.
- Polarization across sectors and regions is linked to uneven income distributions and weakened social cohesion.

### Demographic outlook and implications for labor reform
- Korea is expected to face stronger headwinds from a shrinking and aging population.
- Current projections in the text indicate Korea will become the second oldest country in the world by 2060, "only next to Qatar".
- Population is noted as beginning to shrink (phrase present in the supplied text).

### Empirical elements and indicators referenced
- The table of contents and figures referenced in the source point to related indicators and empirical material, including:
  - Employment Protection Index (2012)
  - Share of Temporary Employment (2012)
  - Product Market Regulation Index (2013)
  - Figures on income inequality (Gini), labor income growth by income group, income share of top 10 percent, and poverty rate of the elderly population

### Implications highlighted in the supplied text
- Labor market reforms are framed as essential to address slowing growth, entrenched dualities, and the socialization of corporate losses.
- Strengthening social cohesion is presented as important to enable politically difficult structural reforms.

*Source: wp17260 - 1. Labor Market Reforms (excerpt provided)*

### 2030. Age-related public spending (for instance, health care spending) will rise rapidly while

### 2030. Age-related public spending (for instance, health care spending) will rise rapidly while

### Major findings: structural headwinds and macroeconomic trends
- Age-related public spending will rise rapidly and the national pension fund is projected to be depleted by 2060.
- Korea is subject to the global productivity slowdown that started well before the global financial crisis.
- Domestic imbalances have grown and entrenched across dimensions: between large and small firms, between manufacturing and services, and between the metropolitan area and other localities.
- Growth accounting for Korea, 2001–15 (in percent):
  - 2001–05: Real GDP 4.7; Capital 2.1; Labor 1.0; TFP 1.5
  - 2006–10: Real GDP 4.1; Capital 1.8; Labor 0.5; TFP 1.8
  - 2011–15: Real GDP 3.0; Capital 1.4; Labor 1.0; TFP 0.5
- Demographics and inequality:
  - The elderly are projected to account for 20 percent of Korea’s total population in less than a decade.
  - Corporate revenue growth declined to 0–5 percent by 2015 from 15–20 percent in the early 1990s (large sample of externally-audited firms).
  - Operational profit ratio fell from about 6 percent to 4 percent.
  - Zombie firms (interest coverage ratio <1 for three consecutive years) accounted for 13 percent of all firms as of 2016; 9 percent in manufacturing; 17 percent in services.
  - Labor income growth has fallen relative to profits since the mid-1990s; bottom 10 percent of income distribution experienced virtually no income growth while top 10 percent experienced about 6 per cent per annum.
  - Income share of the top 10 percent rose from less than 30 percent in the 1970s to 45 percent by 2013.
  - Average age of the bottom 10 percent rose from 39 years in 1990 to 65.3 years by 2016.
  - Korea has the highest elderly poverty rate among OECD countries (relative ranking described in text).
- Labor and product market rigidities:
  - Korea ranks high on the Employment Protection Index for regular and temporary employment.
  - Share of temporary employment is high (Figure reference), and unionized workers are about 10 percent of total workers but concentrated in large firms.
  - During 2012–16, an average of more than 100 strikes per year incurred annual loss of 940,000 full working days.
  - Short-term borrowing accounts for about 70 percent of total borrowing by SMEs, versus the OECD average of 46 percent.

### Proposed operational framework for a paradigm shift
- Core objective: simultaneous big push for greater economic freedom (structural reforms) and stronger social protection, within long-run fiscal sustainability parameters.
- Rationale and supporting evidence:
  - Schumpeterian view: economic freedom to work and invest promotes productivity growth via innovation and creative destruction.
  - Inclusive growth is a social choice for Korea given legacy of unbalanced growth and revealed societal preferences favoring inclusiveness.
  - Empirical findings (summarized): tradeoffs between redistribution and growth may be less severe than previously thought; lower net inequality after taxes and transfers is robustly correlated with faster and more durable growth (Ostry et al., 2014).
  - Increasing economic freedom and social protection simultaneously could be mutually reinforcing; structural reforms raise productivity and fiscal space, facilitating social protection; social protection makes economic freedom affordable and reduces downside risks from creative destruction.
- Political economy constraint:
  - Past failure to implement paradigm shift attributed to a social divide on whether growth-promoting structural reforms inevitably worsen inequality and whether redistribution necessarily harms growth.
  - The framework aims to be economically sustainable and politically viable by communicating welfare contributions and enabling bargaining across the divide.

### Structural reforms recommended (to increase economic freedom and allocative efficiency)
- Labor market reforms (three legs: employer flexibility, active labor policies, worker social protection):
  - Amend the Labor Standards Act (LSA): allow layoffs based on good faith and transparent managerial decisions while penalizing unfair labor practices; burden of proof in disputes on management; shorten consultation period before layoffs from 50 business days to 30 business days.
  - Institutionalize flexible labor contracts and prohibit unjustified discrimination against temporary workers; reform mandatory conversion of temporary to permanent employment (current two-year rule) to avoid perverse incentives.
  - Incentivize active job training and job search: structure unemployment insurance to provide larger and longer benefits to those more active in training and search; establish central-local policy network to share job information and minimize duplication.
- Financial sector reforms:
  - Convert financial business regulations into a negative system (institutions can operate unless restricted), paired with upgraded prudential regulation and supervision; adopt a gradual approach.
  - Improve access to long-term financing for SMEs: short-term borrowing is about 70 percent of SME borrowing (OECD average 46 percent), creating vulnerability.
  - Specific measures:
    - Refocus Korea Development Bank (KDB): increase balance sheet exposure to venture businesses from current 7 percent to 30 percent; restructure governance to separate venture investment decisions from directed lending.
    - Share or reduce financial risk for banks: provide low cost matching funds earmarked for lending to SMEs and start-ups at maturities of three years or longer, and share losses from non-performing loans.
    - Broaden eligible collateral menu: develop statistical framework to assess collateral value of movable assets and property rights owned by SMEs; consider establishing a public agency to lead evaluation.
    - Lower bar for equity financing for venture firms: reduce KOSDAQ listing thresholds from current 30 billion won and 3 billion won to 25 billion won and 1.5 billion won, respectively.
  - Caution: too-drastic deregulation risks worsening SME access until banks develop sophisticated data-based lending and venture capital markets deepen; targeted government support and incentives recommended in interim.
- Other reforms:
  - Deregulate business investment in real estate in the Seoul metropolitan area; address regional imbalances via fiscal transfers rather than geography-based business location restrictions.
  - Further liberalize immigration and foreign direct investment to relax resource constraints from demographic headwinds and to improve firms’ access to foreign labor and capital.
  - Strengthen surveillance and enforcement against unfair business practices alongside deregulation.

### Social protection measures for inclusive growth and fiscal implications
- Policy intent: make economic freedom affordable to all by cushioning risks from creative destruction and enabling investment in human capital.
- Priority social protection measures highlighted:
  - Increase unemployment insurance benefits and tie benefit generosity to job training and active job search participation.
  - Stabilize low-income households’ cost of living via targeted measures (housing, child care, college education supports described as weak indirect protections).
  - Address elderly poverty: national pension provides only minimum protection; elderly poverty rate is highest among OECD countries.
- Fiscal cost estimates:
  - Gross fiscal cost of improved social protections estimated on the order of 4 percent of GDP per year over the period of 2018–22.
  - Net fiscal cost estimated at less than 2 percent of GDP per year after expenditure restructuring and tax increases.
  - Public debt dynamics are unlikely to be affected given accompanying expenditure restructuring, tax increases, and potential growth dividends from structural reforms.
  - A simple debt sustainability exercise suggests room for debt financing if structural reforms raise permanently the real GDP growth rate.
- Implementation and sequencing:
  - Social protection expansions should be financed by a combination of expenditure restructuring and tax increases.
  - Stronger social protection would facilitate structural reforms by reducing political resistance and by supporting workers through transitions, while higher growth from reforms would ease fiscal constraints.

### Political and implementation considerations
- Historical context: earlier reform episodes (post-1997–98 crisis) delivered some macro regime changes and corporate governance improvements but did not resolve remaining and newly created inefficiencies.
- Social cohesion has weakened as younger generations are less certain that hard work leads to success, complicating consensus building for reforms.
- The proposed framework emphasizes a communications strategy and analytical framework to convey welfare contributions of reforms to both sides of the social divide, aiming to produce a politically viable bargaining equilibrium.

*Source: IMF Working Paper wp17260 (excerpt).*

### 1.      Measures of Social Protection and Spending Needs

### 1.      Measures of Social Protection and Spending Needs

### A. Unemployment Benefits — current situation and rationale
- Unemployment benefits are currently less than what workers would make by working full time at the minimum wage, and coverage is capped at eight months.
- About 30 percent of wage earners and most of the self-employed are not covered by any unemployment insurance.
- Given limited support, labor market reforms are estimated to put more than half million households into poverty under the current system of unemployment insurance (Byeon, 2017).

### A. Unemployment Benefits — proposed measures
- Increase the replacement ratio (ratio of unemployment benefits to the average salary of all workers over three months prior to layoff) from 60 percent to 80 percent in two steps.
  - Immediate increase to 70 percent would be just sufficient to cover the minimum cost of living for a head of household with three dependents.
  - Raise to 80 percent in a second step to help cover some job search and training costs.
- Extend the maximum payment duration to 18 months.
  - Expected to increase the average payment duration to eight months, up from three months.
  - Note: further extension to 24 months or longer could be considered over time as fiscal capacity permits, but a cautious approach is advised to avoid weakening work incentives.
- Front load disbursement of unemployment benefit using contingent allowances.
  - Unemployed can receive one half of the unpaid benefit as an allowance if employed before the end of the entitlement period.
  - The share of such allowance is currently about 4½ percent of total disbursements, but can be increased to 8 percent by 2025.
- Make coverage universal.
  - Level of assistance set to make up for the difference between household income of the uninsured worker during unemployment and the minimum cost of living.
  - Universal coverage expected to prevent uninsured workers falling into poverty and encourage self-employment and innovation.

### A. Unemployment Benefits — spending needs and labor market projections
- Labor market reforms, if fully implemented, are estimated to increase the unemployment rate from 3 percent to 7 percent in the short run before bringing it back to 3 percent in the medium term (Byeon, 2017).
- Unemployment rate for youth is projected to rise to 12–13 percent temporarily before stabilizing at 6 to 7 percent.
- Total spending need for the proposed unemployment measures is estimated to be about 125 trillion won in total over the period of 2018–22.

### B. Stabilizing the Cost of Living of Low-income Households — rationale
- Stabilizing the cost of living can provide more effective protection than direct income support for unskilled, low-income workers.
- Three basic needs highlighted: housing, child care, and education.
- Housing context:
  - Ratio of rents to income increased from 18.7 percent in 2006 to 20.3 percent by 2014.
  - Ratio of housing units to number of households was 103.5 percent in 2014.
  - Share of households living in rental or leasing units increased from 39 percent in 2006 to 42 percent in 2014.
  - Share of households living in public rental units remains at less than 6 percent.
- Child care and fertility context:
  - Public spending of about 80 trillion won in total during the last decade devoted to increasing the fertility rate.
  - Fertility rate increased marginally from 1.12 in 2006 to 1.17 in 2016.
  - Current public support mostly provided as subsidy to service providers, with administrative oversight challenges and leakage.
- Education context:
  - About 70 percent of high school graduates go to college.
  - Low-income households who cannot afford college education are increasingly marginalized in the job market.

### B. Stabilizing the Cost of Living — proposed measures
- Increase supply of long-term public rental housing to raise the share of households living in public rental units to 20 percent by 2022.
  - Existing stock: 1.2 million units as of 2017.
  - Additional supply needed: 2.9 million units, achieved by:
    - 1.7 million units through “build (new homes) and rent”,
    - 0.35 million units through “buy (existing homes) and rent”,
    - 0.85 million units through “lease (existing homes) and rent”.
- Introduce child allowances:
  - 200,000 won per month for a child aged 4 or less.
  - 100,000 won per month for a child aged 5 to 9.
  - Expected benefits include potential fertility increases (example given: France), and greater economic freedom for women to re-enter the workforce.
- Provide high school education free of cost for all, and subsidize college education.
  - Two implementation options for college subsidies:
    - Needs-based scholarships for low-income households (better targeted, administratively/politically harder).
    - Broader subsidization of colleges reducing tuition for all students (costlier, easier to implement).

### B. Stabilizing the Cost of Living — spending needs
- Total spending needs from these measures: about 168 trillion won in total over the period of 2018–22.
- Public rental housing:
  - Supplying an additional 2.9 million units would cost 331 trillion won over 2018–22:
    - 233 trillion won for “build and rent”,
    - 33 trillion won for “buy and rent”,
    - 65 trillion won for “lease and rent”.
  - Out of 331 trillion won, 221 trillion won can be covered by the existing public housing investment fund (Housing City Fund) and the public agency (Korea Land and Housing Corporation).
  - Net fiscal cost to the central government: 110 trillion won over 2018–22.
- Childcare allowances:
  - Net fiscal cost estimated at about 39 trillion won over 2018–22.
  - This estimate reflects savings from abolishing existing family care allowances (1.2 trillion won per year) and child care subsidies (8.8 trillion won per year).
- Education:
  - Providing high school education for free expected to cost 4 trillion won over 2018–22.
  - Expected net cost of subsidizing college education: 14–15 trillion won over 2018–22 (incorporates possible savings from reduced budget support for national college scholarships and reduced high school enrollment given projected demographic trends).

### 2.      Funding for Increased Social Protection — aggregate needs and principles
- Total spending needs associated with the proposed social protection measures: 293 trillion won over the period of 2018–22, or 4 percent of annual GDP.
- About two thirds of total spending need (excluding spending for public housing) are permanent in nature.
- Given magnitude and permanence, funding should come primarily from permanent expenditure restructuring and tax increases to assure fiscal sustainability.

### 2.A. Expenditure Restructuring — proposed measures and estimated savings (2018–22)
- Restructure the Employment Protection Fund:
  - Transfer maternity benefits (currently covered as part of unemployment benefits) to the National Health Insurance Fund.
  - Raise the contribution rate of unemployment insurance by 1 percentage point (to 2.82 percent).
  - Expected savings: 13 trillion won.
- Restructure the social welfare budget:
  - Cut budget support to local governments and civil organizations that are inefficient/wasteful.
  - Strictly enforce collection of contributions to national health insurance and national pension funds to remove arrears.
  - Raise the retirement age.
  - Expected savings: 16–17 trillion won.
- Cut and rationalize public R&D investment:
  - Focus on basic research only, abolish budget support for R&D by firms.
  - Expected savings: 48 trillion won.
- Rationalize public investment projects:
  - Improve efficiency of job creation projects; consolidation with employment insurance fund.
  - Expected yield: 21.7 trillion won for 5 years.
  - Consolidation into employment insurance fund and unemployment benefits can save 15.5 trillion won.
  - Job-search incentive program (budget 2.8 trillion won): reduce by 30–40 percent to save 6.2 trillion won.
- Reduce duplication in age/fertility related spending:
  - Streamline and merge budgets (35 trillion won in 2016).
  - Expected savings: 7 trillion won over 2018–22.
- Rationalize lending to SMEs and start-up firms:
  - Reduce budget earmarked by 20 percent.
  - Expected savings: 4–5 trillion won.

### 2.B. Tax Measures
- Increase tax rates where economically least distortionary and socially equitable.
- Proposed framework envisages an increase in tax revenue of 107 trillion won over the period of 2018–22 by raising tax rates.
- Byeon (2017) proposed an increase in the value-added tax (VAT) rate from the current 10 percent to 15 percent in two steps during the period of 2018-22.

*Source: wp17260 - 1.      Measures of Social Protection and Spending Needs (IMF working paper content provided)*

### introduction 1977, which is about half of the OECD average of 19.2 percent. Consequently, revenue from the

### wp17260 - introduction 1977, which is about half of the OECD average of 19.2 percent. Consequently, revenue from the

### Funding sources and proposed revenue measures
- Context: "1977, which is about half of the OECD average of 19.2 percent. Consequently, revenue from the VAT accounts for less than 4 percent of total tax revenue, compared to the OECD average of 6.3 percent."
- Personal income tax reforms
  - "Increase the transparency and progressivity of personal income taxes. Raise tax rates for the highest income brackets, simplify the tax code, and shift to total income tax (rather than taxing differently individual incomes such as wage income, interest and rental incomes, and dividends, etc.)."
  - Expected revenue gain: "14–15 trillion won."
- Coal consumption tax
  - "Introduce the consumption tax on coal used for power generation. Increase the consumption tax rate on coal used for power generation from 33 won/kg to 47 won/kg."
  - Expected revenue gain: "6 trillion won."
  - Co-benefit: "help save on health care costs by improving air quality."
- Tax exemptions and tax expenditures
  - "Reduce and streamline tax exemptions: Avoid excessive use of changes in tax exemptions as part of cyclical fiscal policy."
  - Expected savings on tax expenditures: "17–18 trillion won."
- Sales of government shares of SOEs
  - Proposal: "Sell 49 percent of government shares of six fully-owned, unlisted SOEs (including Korea National Oil Corporation)."
  - Book value of those unlisted SOEs: "85 trillion won, suggesting proceeds of sales of more than 27 trillion won."
  - Valuation assumption: "It is assumed that the market (or sale) value of the government’s share is 65 percent of the book value, which is close to the average of the ratio of the market value to the book value in the past episodes of divestment in SOEs."

### Table 3 — Increasing Social Protection: Funding and budget profile (2018–2022; totals)
- Expenditure restructuring (annual values by year and total, in trillion won)
  - Job protection budget: 2018: "4.0", 2019: "4.6", 2020: "5.2", 2021: "6.0", 2022: "6.8", Total: "26.6"
  - Job creation budget: 2018: "3.5", 2019: "3.9", 2020: "4.3", 2021: "4.7", 2022: "5.3", Total: "21.7"
  - Social welfare budget: 2018: "2.8", 2019: "3.1", 2020: "3.3", 2021: "3.5", 2022: "3.8", Total: "16.5"
  - R&D budget: 2018: "9.6", 2019: "9.6", 2020: "9.6", 2021: "9.6", 2022: "9.6", Total: "48.0"
  - Other budget: 2018: "3.7", 2019: "3.8", 2020: "3.8", 2021: "3.9", 2022: "4.1", Total: "14.3"
  - Subtotal (Expenditure Restructuring): 2018: "23.6", 2019: "25.0", 2020: "26.2", 2021: "27.7", 2022: "29.6", Total: "127.1"
- Taxes and tax expenditures (annual values by year and total, in trillion won)
  - Increases in tax rates: 2018: "15.2", 2019: "8.8", 2020: "24.0", 2021: "25.0", 2022: "34.1", Total: "107.0"
  - Income tax (component): 2018: "1.0", 2019: "3.0", 2020: "3.5", 2021: "3.5", 2022: "3.5", Total: "14.5"
  - Coal consumption tax (component): 2018: "1.2", 2019: "1.2", 2020: "1.2", 2021: "1.1", 2022: "1.1", Total: "5.8"
  - Tax exemptions (component): 2018: "...", 2019: "4.0", 2020: "4.5", 2021: "4.5", 2022: "4.5", Total: "17.5"
  - Subtotal (Taxes and Tax Expenditures): 2018: "17.4", 2019: "17.0", 2020: "33.2", 2021: "34.1", 2022: "43.2", Total: "144.8"
- Others
  - Divestment in SOEs: 2018: "...27.0.........27.0" (presented in table as "27.0" in 2019 and total "27.0")
- Total funding profile (annual and total, in trillion won)
  - 2018: "41.0", 2019: "69.0", 2020: "59.4", 2021: "61.8", 2022: "72.8", Total: "298.9"
- Source attribution in table: "Source: Byeon (2017)"

### Implications for long-run fiscal sustainability and debt financing
- Framework summary: simultaneous "sweeping structural reforms to enhance economic freedom and increased social protection" implies "a significant and permanent increase in public spending."
- Fiscal strategy options
  - Primary approach: "permanent increase in spending to be fully met by a mix of expenditure restructuring and tax increases"—under this, "public debt dynamics and long-run fiscal sustainability are left little changed compared to the status quo scenario."
  - Alternative: limited debt financing if "proposed tax increases create too many distortions" or "if the reforms generate a permanently higher growth rate."
- Debt dynamics equations and implications (as presented)
  - Debt dynamics: (1) ∆dt+1 = ( (rt − gt+1) / (1+gt+1) ) dt − st+1
  - Long-run equilibrium debt ratio: (2) d* = ( (1+g) / (r−g) ) s
  - Change in primary balance needed to keep d* constant after a permanent one-percentage point increase in growth: (3) −∆s = ( d* (1+g)^2 ) [ (1+r) − (1+g) ∂r/∂g ] ∆g
  - For a small open economy where ∂r/∂g ≈ 0: (4) −∆s ≈ A ∙ ∆g, A = [ (1+r) / (1+g)^2 ] d*
- Numeric example from text (no rounding)
  - Assumptions: "g=0.025, r=0.03, and d* =2.0 under the status quo scenario"
  - Result: "a permanent ¼ percentage point increase in the growth rate of real GDP from structural reforms would allow the primary balance to be one half percentage points lower while keeping the debt limit unchanged."
  - Fiscal scaling implication: "the required increase in the tax revenue in our financing plan could be scaled down by about 7 trillion won per year without affecting the fiscal space that would be available under the status quo scenario."
- Caveats and sensitivities
  - The scope for debt financing (captured by −∆s) depends on "the existing debt limit (d*), the level of the real interest rate, and current growth rates of real GDP, and the amount of additional growth various reforms would deliver."
  - It is "negatively affected by the sensitivity of the real interest rate to the real GDP growth rate."

### Key policy recommendations and implementation guidance
- Simultaneous policy package: "a simultaneous big push for structural reforms to enhance economic freedom and social protection" is recommended as "the only viable option to achieve both economic and political support."
- Sequencing and flexibility
  - "The government should exercise flexibility in adjusting the pace and sequencing of spending and tax increases depending on macroeconomic conditions and progress in structural reforms."
  - Examples: "spending increases can be implemented in multiple phases starting from the expansion of unemployment benefits" and "the proposed tax increases could be instituted in several steps rather than at once."
- Risks and implementation challenges
  - The "proposed increase in social protection over the next five years is clearly ambitious" and "may require extraordinary policy efforts to minimize waste and distortions in its delivery."
  - Revenue shortfalls and delayed growth dividends from structural reforms could necessitate pacing adjustments.
- Favorable timing factors cited
  - "growth dividends from structural reforms are likely be larger if started from a low growth rate."
  - "low inflation environment" reduces near-term inflationary risk from fiscal expansion.
  - "low global interest rates would enable the government to borrow at low cost" if debt financing is needed.
  - "public finances are still very sound, with low debt."

### Appendix — Literature survey: structural reforms, growth, and inequality
- Structural reforms and growth (summary)
  - Productivity growth slowed globally since the early 2000s with marked decline after the global financial crisis (Adler et al., 2017).
  - Product market reforms examples: "deregulating retail trade, professional services, and certain segments of network industries (air, rail, and road transportation; electricity and gas distribution; telecommunications and postal services), primarily by reducing barriers to entry."
  - Labor market reforms examples: "increasing the ability of and incentives for the unemployed to find jobs, lowering the costs of and simplifying the procedures for hiring and dismissing regular/permanent workers, harmonizing employment protection legislation for both regular and temporary workers, or cutting the labor tax wedge."
  - Evidence: "product and labor market reforms raise output and employment in the medium term"; short-term payoffs depend on "complementary macroeconomic policies" and sequencing.
  - Misallocation findings: "Hsieh and Klenow (2009) find that resource misallocation in China and India is large enough to cost almost half the aggregate productivity level." "Kim, Oh, and Shin (2017) also show that resource misallocation in Korea has been rising since the 1990s."
- Inequality, redistribution, and growth (summary)
  - Theoretical and empirical ambiguity: inequality can both incentivize growth (Lazear and Rosen, 1981; Kaldor, 1957) and impede growth through human capital, political instability, and weaker consensus (Perotti, 1996; Aghion et al., 1999; Alesina and Perotti, 1996).
  - Empirical evidence generally: "inequality impedes growth, at least over the medium term."
  - Redistribution literature: mixed evidence on whether redistribution harms growth; redistributive spending on health, education, and infrastructure may be benign or pro-growth (Lindert, 2004; Benabou, 2000).
  - Ostry et al. (2014) findings highlighted:
    - "More unequal societies tend to redistribute more."
    - "Lower net inequality is robustly correlated with faster and more durable growth, for a given level of redistribution."
    - "Redistribution appears generally benign in terms of its impact on growth; only in extreme cases is there some evidence that it may have direct negative effects on growth."

*Source: IMF working paper wp17260 (selected sections as provided).*

### References

### References

### Inequality, redistribution, and growth
- Aghion, P., E. Caroli, and C. Garcia-Penalosa, 1999, “Inequality and Economic Growth: The Perspective of the New Growth Theories,” Journal of Economic Literature, Vol. 37(4), pp. 1615–60.  
- Aghion, P., U. Akcigit, A. Bergeaud, R. Blundell, and D. Hemous, 2015, “Innovation and Top Income Inequality,” NBER Working Paper No. 21247.  
- Alesina, A., and R. Perotti, 1996, “Income Distribution, Political Instability and Investment,” European Economic Review, Vol. 40(6), pp. 1203–28.  
- Alesina, A., and D. Rodrik, 1994, “Distributive Politics and Economic Growth,” Quarterly Journal of Economics, Vol. 109(2), pp. 465–90.  
- Barro, Robert, 2000, “Inequality and Growth in a Panel of Countries,” Journal of Economic Growth, Vol. 5(1), pp. 5–32.  
- Bassett, W., J. Burkett, and L. Putterman, 1999, “Income Distribution, Government Transfers, and the Problem of Unequal Influence,” European Journal of Political Economy, Vol. 15(2), pp. 207–28.  
- Benabou, R., 2000, “Unequal Societies: Income Distribution and the Social Contract,” American Economic Review, Vol. 90(1), pp. 96–129.  
- Benhabib, J., 2003, “The Tradeoff Between Inequality and Growth,” Annals of Economics and Finance, Vol. 4(2), pp. 491–507.  
- Easterly, W., 2007, “Inequality Does Cause Underdevelopment: Insights from a New Instrument,” Journal of Development Economics, Vol. 84(2), pp. 755–76.  
- Galor, O. and O. Moav, 2004, “From Physical to Human Capital Accumulation: Inequality and the Process of Development,” Review of Economic Studies, Vol. 71(4), pp. 1001–26.  
- Milanovic, B., 2000, “The Median Voter Hypothesis, Income Inequality, and Income Redistribution: An Empirical Test with the Required Data,” European Journal of Political Economy, Vol. 16(3), pp. 367–410.  
- Okun, A., 1975, Equality and Efficiency: The Big Trade-Off, Brookings Institution Press, Washington.  
- Ostry, J., A. Berg, and C. Tsangarides, 2014, “Redistribution, Inequality, and Growth,” IMF Staff Discussion Note 14/02 (Washington: International Monetary Fund).  
- Perotti, R., 1996, “Growth, Income Distribution, and Democracy: What the Data Say,” Journal of Economic Growth, Vol. 1(2), pp. 149–87.  
- Persson, T. and G. Tabellini, 1994, “Is Inequality Harmful for Growth?” American Economic Review, Vol. 84(3), pp. 600–21.  
- Saint-Paul, G., and T. Verdier, 1993, “Education, Democracy and Growth,” Journal of Development Economics, Vol. 42(2), pp. 399–407.  
- Saint-Paul, G., and T. Verdier, 1997, “Power, Distributive Conflicts, and Multiple Growth Paths,” Journal of Economic Growth, Vol. 2(2), pp. 155–68.  
- Bassanini, A., L. Nunziata, and D. Venn, 2009, “Job Protection Legislation and Productivity Growth in OECD Countries,” Economic Policy, Vol. 24 (58), pp. 349–402.

### Innovation, productivity, and misallocation
- Adler, G., R. Duval, D. Furceri, S. Çelik, K. Koloskova, and M. Poplawski-Ribeiro, 2017, “Gone with the Headwinds: Global Productivity,” IMF Staff Discussion Note, 17/04 (Washington: International Monetary Fund).  
- Akcigit, U., J. Grigsby, and T. Nicholas, 2016, “The Rise of American Ingenuity: Innovation and Inventors of the Golden Age,” NBER Working Paper No. 23047.  
- Aghion, P., C. Harris, and J. Vickers, 1997, "Competition and Growth with Step-by-Step Innovation: An Example", European Economic Review, Vol. 41, No 3, pp. 771–782.  
- Hsieh, C. and P. Klenow, 2009, “Misallocation and Manufacturing TFP in China and India.” Quarterly Journal of Economics, Vol. 124(4), pp. 1403–448.  
- Kim, M, J. Oh, and Y. Shin, 2017. “Misallocation and Manufacturing TFP in Korea, 1982–2007,” Federal Reserve Bank of St. Louis Review.  
- McMillan, M. and D. Rodrik, 2011, “Globalization, Structural Change and Productivity Growth,” in Making Globalization Socially Sustainable, ILO-WTO.  
- Lazear, E. and S. Rosen, 1981, “Rank-Order Tournaments as Optimum Labor Contracts,” Journal of Political Economy, Vol. 89(5), pp. 841–64.

### Labor markets, regulation, and structural reform
- Blanchard, O. and F. Giavazzi, 2003, “Macroeconomic Effects of Regulation and Deregulation in Goods and Labor Markets,” Quarterly Journal of Economics, Vol. 118(3), pp. 879–907.  
- Ahn, JaeBin, 2017, “Structural Changes and Economic Development: A Cross-Country Analysis of the Role of Labor Market Regulation,” mimeo.  
- Koske, I., I. Wanner, R. Bitetti, and O. Barbiero, 2015, “The 2013 Update of the OECD’s Database on Product Market Regulation: Policy Insights for OECD and non-OECD Countries,” OECD Economics Department Working Paper 1200 (Paris: Organization for Economic Co-operation and Development)  
- International Monetary Fund, 2015, “Structural Reforms and Macroeconomic Performance: Initial Considerations for the Fund.” IMF Staff Report (Washington).  
- International Monetary Fund, 2016, “Time for a Supply-Side Boost? Macroeconomic Effects of Labor and Product Market Reforms in Advanced Economies,” Chapter 3, World Economic Outlook, April (Washington).  
- Organization for Economic Co-operation and Development, 2015, Economic Policy Reforms: Going for Growth, Paris

### Fiscal policy, government size, and macro stability
- Ghosh, A., J. Kim, J. Ostry, M. Qureshi, and E. Mendoza, 2013, “Fiscal Fatigue, Fiscal Space and Debt Sustainability in Advanced Economies,” Economic Journal, 123, pp 4–30.  
- Meltzer, A., and S. Richard, 1981, “A Rational Theory of the Size of Government,” Journal of Political Economy, Vol. 89(5), pp. 914–27.  
- Lindert, P., 2004, Growing Public: Social Spending and Economic Growth Since the Eighteenth Century (Cambridge, U.K.: University Press).  
- Tanzi, V. and H. Zee, 1997, “Fiscal Policy and Long-Run Growth,” IMF Staff Papers, Vol. 44(2), pp. 179–209 (Washington: International Monetary Fund).  
- International Monetary Fund, 2017, “Achieving More with Less,” Fiscal Monitor, April (Washington).

### Political economy, conflict, and growth collapses
- Rodrik, Dani, 1999, “Where Did All the Growth Go? External Shocks, Social Conflict, and Growth Collapses,” Journal of Economic Growth, Vol. 4(4), pp. 385–412.  
- Alesina, A., S. Ardagna, G. Nicoletti, and F. Schiantarelli, 2005, “Regulation and Investment,” Journal of the European Economic Association, 3 (4): 791–825.  
- Berg, A., J. Ostry, and J. Zettelmeyer, 2012, “What Makes Growth Sustained?” Journal of Development Economics, Vol. 98(2), pp. 149–66.  
- Bassanini, A., L. Nunziata, and D. Venn, 2009, “Job Protection Legislation and Productivity Growth in OECD Countries,” Economic Policy, Vol. 24 (58), pp. 349–402.

### Country-specific studies and policy notes
- Byeon, Yangkyoon, 2017, Rethinking Korea’s Paradigm Shift, Badabooks Press, Seoul.  
- Kim, Hisam, 2015, “Resetting Education Policy to Restore Social Mobility,” KDI Focus, No. 54, September.  
- Organization for Economic Co-operation and Development, 2016, OECD Economic Surveys: Korea 2016 (Paris: Organization of Economic Cooperation and Development).  
- Jaimovich, N., and S. Rebelo, 2012, “Non-Linear Effects of Taxation on Growth,” NBER Working Paper No. 18473.

*wp17260 - References*

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_Source: https://www.imf.org/-/media/files/publications/wp/2017/wp17260.pdf_