Korea’s higher wages backfire as firms cut back hiring to protect profit margin

It seems simple: Korea has labor market woes, and to solve it, President Moon proposes higher minimum wage , more fiscal spending on social safety net, and higher taxation on larger corporates. But there lies the rub. By adding to already rising labor costs to firms’ bottom line and high taxation, firms accelerate an existing trend – increase offshoring of production to lower cost locations such as Vietnam. Meanwhile, labor intensive small and medium enterprises (SMEs) are not as flexible as larger firms and have to bear the brunt of higher input costs, and they cope by reducing headcount . As a result, South Korea’s headcount demand shrinks further, particularly in tradeable sectors such as manufacturing. And that has a consequence of reducing investment onshore – the latest Q2 2018 GDP figure shows a contraction of investment. Although part of this is driven by the downturn of the trade cycle, it also reflects higher production costs forcing firms to invest elsewhere. For example, South Korea’s overseas ’ direct assets continue to growth – indicating that for Korean firms ’ growth opportunities are increasingly elsewhere. This is something we forecasted would happen regarding higher minimum wage costs proposed by President Moon. And clearly, this couldn’t come at a worse time for South Korean firms as they face increased competition from neighbors such as China and Japan as well as uncertainty regarding trade war, not to mention tax cuts and incentives making investment in the US relatively more competitive. While large Korean corporation cope with this by offshoring and having high research and development , which make them competitive in global markets, smaller, labor-intensive and domestic-oriented firms have a harder time as they cannot easily reorganize business operations to reduce costs . President Moon respond ed to this on Sunday with stronger calls for income-led growth strategy as worsening labor market data requires an acceleration of policy support rather a slowdown . The question is whether the rise of nominal minimum wage can offset the negative impact of higher labor costs, which disproportionately hurt SMEs and the poor as larger firms accelerate offshoring. So far, the data has not been supportive as profit margin shrinks.