Korea’s Challenges Ahead—Lessons from Japan’s Experience

IMF Working Papers, January 18, 2017

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The paper draws parallels between Korea and Japan across demographics, potential growth, balance sheets, asset prices, and inflation.
Korea’s demographic trends seem to track Japan’s with a lag of about 20 years.
New econometric analysis presented in the paper suggests that aging will exert a downward drag on Korea’s inflation going forward.
Korea does not appear to be headed toward deflation, according to the paper’s assessment.

Demographics and growth:
- Korea’s demographic trends seem to track Japan’s with a lag of about 20 years.
- Aging is projected to exert a downward drag on inflation (new econometric analysis).
Productivity and labor markets:
- Low productivity in the service sector is a shared challenge for Korea and Japan.
- Labor market duality is common to both countries and weakens overall labor market performance.
Corporate balance sheets and restructuring:
- Korea’s corporate balance sheets are stronger than Japan’s in the early 1990s.
- Despite stronger balance sheets, Korea needs to progress with the restructuring of nonviable firms to avoid adverse consequences of delayed balance-sheet repair similar to Japan’s experience.
Asset prices and macroprudential policy:
- Korea can prevent bubbles in asset prices (which were at the origin of Japan’s initial crisis) through continued use of macroprudential policies.
Fiscal capacity:
- Given its strong fiscal balance-sheet position, Korea can afford using fiscal policy actively to incentivize corporate restructuring and structural reforms and to cushion their possible short-term adverse impact.

Structural reforms:
- Address low productivity in the service sector through targeted structural reforms.
- Reduce labor market duality to improve labor market performance and productivity.
Corporate restructuring:
- Accelerate restructuring of nonviable firms to avoid delayed balance-sheet repair and its adverse consequences.
- Use fiscal incentives to facilitate corporate restructuring where appropriate.
Macroprudential and fiscal policy:
- Continue and strengthen macroprudential policies to prevent asset-price bubbles.
- Deploy fiscal policy actively—taking advantage of a strong fiscal balance-sheet position—to incentivize reforms and cushion short-term costs.

The paper’s new econometric analysis indicates aging will exert a downward drag on Korea’s inflation going forward, even though the country does not appear to be headed toward deflation.

Edda Zoli, "Korea’s Challenges Ahead—Lessons from Japan’s Experience", IMF Working Paper No. 2017/002, January 18, 2017.

Korea’s Challenges Ahead-Lessons from Japan Experience
- Korea’s Challenges Ahead-Lessons from Japan Experience (Markdown version)
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