Two roads diverged in Korean yellow woods. Will Korea remain on the road less traveled and maintain its cumbersome regulatory framework governed by an inefficient, illogically burdensome, and self-interested bureaucracy or will Korea free itself from this autocratic regulatory regime and bureaucracy and choose the other road?
In a country with a notoriously Sybil-type personality, only the most arrogant of pontificators will take a stab at predicting the future of Korea. I have ventured into this area on a number of occasions and will gladly take a stab if asked during the question and answer session.
What is definitely known, however, is that economists and business professionals nearly unanimously opine that we must free ourselves from autocratic, authoritarian, and government-focused regulatory regimes in order for the people of nations to prosper. In short, we must respect and foster economic freedom.
The leading indicator of economic freedom is the Index of Economic Freedom . The Index was developed by the Wall Street Journal and the Heritage Foundation and has empirically established, over its 15-year history that those nations that have increased scores year-on-year have nearly universally increased their economic prosperity and those nations with high scores are the most prosperous nations.
Korea ranks low on this and other like indexes, but will increase its scores because of the Lee Myung Bak Administration, the New Right and the moral pressure of reformist stalwarts such as Park Gun Hye.
The Park Administration has made significant regulatory reforms during its Administration, but has been unable to thwart the efforts of a vocal radical liberal minority that is capable of manipulating the population into believing their anti-American, anti-free trade, anti-foreign capital, and pro-militant labor policies.
With this in mind, this discussion was developed.
Part I of this discussion will address the link between the promotion of economic freedom and prosperity, while detailing Korea¡¯s rank on the Index and other like indexes. Part II will discuss the major regulatory reforms of the Lee Myung Bak Administration.
I. The Role of Economic Freedom in our not so Brave New World
A. The Financial Crisis and Economic Freedom
The financial crisis has caused many to question the efficacy of classical economics and free markets. We should not forget that since the late 1970s the adoption of classical economic principles and free market principles spread throughout the world lifting hundreds of millions of people out of poverty and spreading the value of free markets to China, Russia, and India.
Our financial crisis, however, led governments to intervene in ways that were not seen since the Great Depression. Hopefully, this is not a trend in the making. We can¡¯t forget that the main cause of this financial crisis is the same governments that now are pretending to save us.
Their policies led to distorted interest rates and asset prices, loans to un-creditworthy borrowers and, eventually, the destruction of our markets.
The first culprit was Alan Greenspan and his serfs at the Federal Reserve. Since 2001, they have drastically increased the money supply while reducing the federal funds rate.
The drastic increase in the money supply led to the increased availability of credit, which overwhelmingly went into real estate. This Fed-induced and credit-fueled artificial demand led to an overheated real estate market and a drastic increase in the construction of new homes.
The dramatic decrease in the federal funds rate from 6.25 percent to 1.75 percent led to a negative rate, in real terms. The interest rates were lower than the inflation rate, leading to more adjustable-rate mortgages (ARMs), since short-term interest rates were much lower than long-term interest rates.
The Fed-induced low short-term interest rates led to almost 40 percent of homebuyers choosing ARMs by 2004. When short-term rates began to climb and mortgages adjusted up, many of these new homeowners were unable to pay their mortgages.
The second culprit was a government that encouraged and even mandated the writing of risky mortgages. In 2006, over 23 percent of mortgages were classified as ¡°nonprime.¡± The vast majority included only a small down payment.
The culprits in the government include an administration that extended the Community Reinvestment Act and the Home Mortgage Disclosure Act, the Department of Housing and Urban Development, the Federal Housing Administration, and Fannie Mae and Freddie Mac.
The Community Reinvestment Act and related acts made it more difficult for lenders to receive acceptable bank ratings, which, after the amendments, were heavily influenced by how well a lender ¡°served¡± low, moderate income and minority borrowers.
Without acceptable ratings, banks did not receive permission to merge or establish new branches.
Secondly, the Department of Housing and Urban Development (HUD) lowered payment requirements to only 3 percent. Many private lenders, in order to compete, followed suit. These low down payment mortgages were some of the first to fail.
The Department of Housing and Urban Development also strong-armed lenders to offer loans to ¡°nonprime¡± borrowers by suing lenders who declined higher percentages of minority applicants, leading to many lenders not only evaluating credit risk but evaluating lawsuit risk.
Finally, Fannie Mae and Freddie Mac grew to hold over half of the U.S. mortgage market. HUD set ¡°affordable housing¡± goals; 52 percent of borrowers had to be below-median income earners.
Institutional investors were more than willing to feed these goliaths since they had the implicit guarantee of the U.S. government.
Many in D.C. tried to reign in on them but they had the strong backing of some of the most powerful people in Washington, including our usually regulation-friendly Barney Frank, chairman of the House Financial Services Committee, who strongly opposed plans to monitor Fannie Mae and Freddie Mac, noting that the agencies ¡°are not facing any kind of financial crisis. . ..The more people exaggerate these problems, the more pressure there is on these companies, the less we will see in terms of affordable housing.¡±
He added, in a House hearing, that ¡°there has been more alarm raised about potential unsafety and unsoundness than, in fact exists . . . I want to roll the dice a little bit more in this situation toward subsidized housing.¡±
Hopefully, we can give credit where credit is due and learn, as Professor Lawrence White has noted, that ¡°[c]heap-money policies by the Federal Reserve system do not produce a sustainable prosperity. Hiding the cost of mortgage subsidies off-budget, as by imposing ¡®affordable housing¡¯ regulatory mandates on banks and by providing implicit taxpayer guarantees on Fannie and Freddie Mac bonds, does not give us more housing at nobody's expense.''
The fault of this crisis is not ¡°deregulation,¡± but ¡°bad or feckless regulation, not the lack of it. Adam Smith in his ruthless fashion has already punished the biggest mistakes, remaking Wall Street without Congress having passed a single reform. Thanks to revised market discipline, the world is already moving to a safer, more stable financial system.¡±
B. What is Economic Freedom
The existence of a free market does not of course eliminate the need for government. On the contrary, government is essential both as a forum for determining the ¡°rules of the game¡± and as an umpire to interpret and enforce the rules decided on. What the market does is to reduce greatly the range of issues that must be decided through political means, and thereby to minimize the extent to which government need participate directly in the game.
Economic freedom is broken down by the Index into ten categories.
1. Business Freedom: Freedom to create, operate, and close an enterprise.
2. Trade Freedom: Openness to foreign goods and traders.
3. Fiscal Freedom: Freedom to keep and control wealth.
4. Government Size: Freedom from the burden of excessive government.
5. Monetary Freedom: Stable currency and freedom to have market-determined prices.
6. Investment Freedom: Freedom from restrictions on the use of capital.
7. Financial Freedom: Freedom from excessive banking and financial regulations.
8. Property Rights: Government protection of private property.
9. Freedom from Corruption: Freedom from bribery, extortion, nepotism, cronyism,
patronage, embezzlement, and graft.
10. Labor Freedom: Freedom of contract, freedom to work, and voluntary exchange.
C. Why Does Economic Freedom Matter?
(Nations) Score GDP (PPP) Countries Human Development Index
(7) 80 + USD 40,253 Hong Kong, Singapore, Australia, Ireland, New Zealand, U.S. and Canada
(23) 70-80 USD 33,428 U.K., Iceland, Japan, Macau, Austria, Netherlands, Germany, Sweden, Norway, and Spain 0.92
(53) 60-70 USD 15,541 South Korea, Taiwan, Israel, Mexico, France, Thailand, Italy, Poland, and Greece 0.80
(67) 50-60 USD 4,359 Egypt, the Philippines Brazil, India, China, Indonesia, Vietnam and Russia 0.62
(29) Below 50 USD 3,926 Liberia, Bangladesh, Iran, Venezuela, Cuba, and North Korea 0.59
1. Economic Freedom is directly correlated with Economic Prosperity
¡°Per capita incomes are much higher in countries that are economically free. Countries rated ¡®free¡¯ or ¡®mostly free¡¯ in the 2009 Index enjoy incomes that are more than double the average levels in all other countries and more than eight times higher than the incomes of countries that are ¡®repressed¡¯ economies.¡±
2. Economic Freedom Promotes Democracy
¡°Great Economic Freedom can also provide more fertile ground for effective and democratic governance. It empowers people to exercise greater control of their daily lives. By increasing options, economic freedom ultimately nurtures political reform as well.¡±
Many empirical studies have been done on this correlation including the Economist Intelligence Unit¡¯s Democracy Index. These studies have proven the direct correlation between economic freedom and democracy.
3. Economic Freedom Promotes Human Development
The United Nations Human Development Index has shown that economic freedom allows greater access to education, high quality health care, quality food and clean drinking water and a longer life expectancy.
In economically free societies, children go to school rather than to work, trees are valued for their shade rather than as fuel, workers worry about job safety rather than unemployment, and hospitals are places of hope rather than despair.
Economic freedom is the revolutionary economic counterpart to democratic pluralism. It empowers the poor and builds the middle class. It is a philosophy that encourages entrepreneurship and disperses economic power and decision-making throughout an economy. Governments that embrace the desires of their citizens for growing and sustainable prosperity will find the surest path to be that which is also the widest and most open, offering each individual the chance to walk freely in their own way toward a better future.
D. Korea¡¯s Rankings
Scores of 80 or more are generally considered ¡°free economies.¡± Only seven out of the 179 countries economies graded received scores in the 80s. 23 nations received scores between 70 and 80 and these nations are examples of economies that are ¡°mostly free.¡± So only 30 countries, or one-sixth of the economies ranked, received a ¡°mostly free score.¡±
Korea¡¯s score is 68.1, which ranks it 40th in the world behind Hong Kong, Singapore, Australia, New Zealand, Japan, Macau and Taiwan in the region. Korea is on par with Malaysia and Thailand in the region and 10 points away from the top 10. It is ranked a ¡°Moderately Free¡± nation.
Improvements are needed with regard to trade freedom, fiscal freedom, government size, investment freedom, financial freedom, property rights, freedom from corruption and of course labor freedom.
The most significant short falls are in freedom from corruption, financial freedom and labor freedom. These are three areas that the Lee Administration has been improving.
1. Business Freedom (90.4)
Korea scored a high 90.4 in business freedom. The report notes that starting a business only takes 17 days and obtaining business licenses takes fewer days than the world average.
2. Trade Freedom (70.2)
Korea¡¯s trade freedom needs much improvement. Many areas are still closed to foreign competition and high tariffs, import restrictions, barriers to foreign entry, non-transparent standards and regulations, non-tariff barriers and subsidies make Korea score a mere 70.2.
If more free-trade agreements are negotiated and implemented Korea will improve its score in this area, but the non-tariffs barriers are still a problem that has not been seriously addressed by the Lee Administration.
3. Fiscal Freedom (70.4)
Korea¡¯s very high income tax rate, and moderately high corporate (corporate and resident tax) rate, moderate VAT tax, capital acquisition and transfer tax, numerous use taxes, and property taxes gives Korea a score of 70.2.
The tax burden in Korea is noticeably more burdensome than regional rivals Hong Kong, Singapore, Taiwan, UAE, Malaysia, and Thailand.
4. Government Size (72.5)
Korea¡¯s total government spending is moderate. Most spending goes to infrastructure projects and privatization of industries is progressing quickly under the Lee Administration. The score is likely to improve in next year¡¯s rankings.
5. Monetary Freedom (80.0)
Korea scores a very respectable 80 in monetary freedom, since the nation has low inflation and up until the financial crisis, a stable currency. The major reason for the nation not scoring in the 90s was numerous policies that distort domestic prices.
6. Investment Freedom (70.0)
The media, electric production, fishing, airlines, numerous agricultural sectors are restricted. Additionally, licensing authorities are not likely to approve products that have not been first utilized by Korean conglomerates in the insurance and other industries and the bureaucracy often acts in an arbitrary and non-transparent fashion.
However, the Korean Regulatory Reform Committee has fought with much success the bureaucratic failings and the Administration has made efforts to promote FDI through free-trade and tax holidays.
Korea, however, because of its numerous restricted industries scores a mere 70 behind most of the regional rivals.
7. Financial Freedom (60.0)
The score for financial freedom is a dismal 60 because of the poor supervision of the financial institutions. However, numerous improvements and liberalization methods have been approved and implemented under the new Administration.
8. Property Rights (70.0)
Korea scores a mediocre 70 in property rights. Deductions were given for an inefficient and slow justice system and the lack of adequate protection for intellectual property rights.
9. Freedom from Corruption (51.0)
The perception of corruption in Korea may be more serious than the reality. Korea ranked a poor 43 out of 179 countries in Transparency International Corruption Perceptions Index for 2007.
The report correctly notes that corruption is perceived because of a non-transparent bureaucracy, exclusionary social, political, and business structures and inefficient institutional checks.
10. Labor Freedom (46.4)
Labor Freedom is the most noticeable short fall in Korea, but there is some good news on the horizon. The Lee Administration is proposing labor law reform and the Administration is enforcing protest, traffic blocking, and strike laws.
However, Korea still has overly restrictive labor laws, regulations and labor shop acts.
II. Reform under the Lee Myung Bak Administration
The Lee Myung Bak Administration has implemented some important regulatory changes. However, many of the most bold of the proposals have been thwarted by a vocal radical liberal minority.
In this section, we will take a look at some of the regulatory changes that have been implemented under President Lee¡¯s Administration.
Some of the information below was adopted from the report by the Presidential Council on National Competitiveness entitled A Year of Regulatory Reform by the Lee Myung Bak Administration
A. Tax System
1. Lower Corporation Tax Rates
To attract foreign investment the corporate tax rate has been lowered from 25% to 20%.
2. Lower Income Tax Rates
Income tax rates have been lowered by 2% in each tax bracket. The government has also implemented a flat-tax for foreigners. The personal income tax rate in Korea is still higher than many of Korea¡¯s competitors in the region.
3. Tax Audits on Multinational Corporations
An MOU signed between the National Tax Service (NTS) and the Korea Customs Service (KCS) will result in a collaborative arrangement of joint tax audits, information exchange and mutual training between the two organizations. This was implemented to effectively remove the situation whereby multinational corporations could be audited by each organization.
I am involved in a case now and have seen no change after the signing of this MOU.
B. Financial System
1. The Capital Market Act
Korea's financial industry is not at a level that would allow it to become Northeast Asia¡¯s financial hub-a stated goal of the Administration.
To assist in making this a reality, the Capital Market Act was enacted on February 4, 2009. I have given a speech on this Act and would be happy to send anyone interested a copy of the speech.
C. Land Utilization
1. Seoul Capital Region
A less stringent policy regarding regulation within the Seoul capital region has been promoted to allow the construction or expansion of factories. Prior to the revision the construction and/or expansion of factories in the Seoul metropolitan area was next to impossible.
2. Industrial Complex Development
Development procedures for industrial complexes have been a complaint by builders for decades. The regulations have been simplified to allow for quicker business investment, reducing the timescale for development from two-four years to around six months.
3. Industrial Complexes for Long-Term Lease
The administration in order to support small and medium enterprises has offered for lease affordably priced land.
The government will offer leases for up to 50 years for modest sums.
1. Environmental Assessment Systems
The environmental assessment system has been revised to allow for quicker processing of applications, reviews, and investigations.
2. Advanced Management of Air Pollutants
The Administration is reviewing the Telemetry Monitoring System (TMS) and Total Air Pollution Load Management System (TAPLMS) and seeks to strike a balance between retaining the effectiveness of the systems and lessening economic burden on businesses.
3. Toxicity Examination of New Chemicals
To reduce cost and time in preparing toxicity documents, which are required for toxicity reviews on new chemicals manufactured or imported into Korea, the law was revised in June 2008. Now certifications from laboratories in other OECD member countries are recognized by the Korean government.
E. Business Start-Ups
1. Starting a Business
With the number of business start-ups on the decrease, the government has introduced changes so that starting a business in Korea has become less complicated and costly. Simplified incorporation procedures have reduced the cost of starting up a business by approximately 95%.
The time to issue a business certificate has also been reduced from 5 days to 3 days.
Foreigners still often note that the business start-up process in Korea is much more difficult than in most of Asia.
StartBIZ will be established in 2010. The website will allow online applications for most business registration purposes, which will speed up the application process, while also allowing enterprises not to have to visit multiple government agencies.
3. Environmental Regulations
Under the last two Administrations environmental regulations were cumbersome and not enforced in a transparent or equal manner.
Revisions to laws concerning low emission creating industries have been made to lessen the burden on industries that are not likely to be contributors to environmental degradation.
Additionally, industrial complexes that are smaller than 5,000 m2 are now exempt from prior environmental review and natural disaster impact statements.
The majority of factories will also not have to use part of their land as green areas.
1. Labor Laws
Labor has been one of the areas where Korea has needed improvement. President Lee has been willing to strictly apply protest and labor strike laws with varying degrees of success. Prior to his Administration, the past two administrations have not enforced protest and labor strike laws, thus, the Administration has had an uphill battle that has led to violence on the street.
G. Copyright Protection
1. Copyright Enforcement
Realizing that the only way to develop the content industry within the country was to provide stronger protection against copyright infringement, the issue has become a key item on the Administration¡¯s national agenda.
There have been numerous crackdowns on counterfeiting by the police and prosecutor¡¯s office, however, the nation still has a vibrant piracy industry.
We end where we began. Two roads diverged in Korean yellow woods. Will Korea remain on the road less traveled and maintain its cumbersome regulatory framework governed by an inefficient, illogically burdensome, and self-interested bureaucracy or will Korea free itself from this autocratic regulatory regime and bureaucracy and choose the other road?
The Lee Administration is on the right road, but will our often violent radical liberal minority burn the trees before we can get to the end of this long journey to economic freedom and prosperity.
*Sean C. Hayes leads the International Corporate Practice Group at Joowon Attorneys at Law, one of Korea's leading law firms. He formerly worked for the Constitutional Court of Korea for six-years and as a professor of constitutional and contract law for five-years. He can be regularly seen in the Korea Times and sailing on the Han River.
** Nathania Whelan is an Irish national with a strong interest in international business transactions. She graduated from the National University of Ireland, Galway with a B.Corporate Law and an LL.B. and passed the New York Bar examination in 2008. She spent two-years researching Biotechnology & the Law with Professor Liam O¡¯Malley and Dr. Oliver Mills at the National University of Ireland, Galway which led to the publication of a note in Commercial Law Practitioner, a leading Irish law journal.