An IMF Working Paper of 23 August 2024 written by Stella Tam and Xin Cindy Xu looks at ways of advancing labour market reforms in Korea.

The study looks at the structural challenges for the labour market in Korea and assesses the macroeconomic consequences of possible labour market reforms. The analysis by the authors indicates that relaxing the employment protection legislation would tend to have positive macroeconomic effects at times when economic growth is strong. However, these reforms could result in further contraction of the economy in periods of recession.

However, the study finds that increasing spending on active labour market policies and making efforts to reduce the labour tax wedge would be more effective in periods of recession. The authors therefore emphasise that it is important to consider the economic conditions when designing labour market reforms. The authors note that the government’s focus on working hour reform appears to be appropriate. As economic growth recovers, they recommend that the government could consider deregulation to reduce employment protection for regular workers while providing targeted support to vulnerable social groups.

The Korean economy is characterised by high labour market rigidity, with high employment protection for both regular and temporary workers, involving a challenging legal procedure and costly severance pay in individual dismissals. Labor market duality is high as Korea has one of the highest shares of non-regular workers in the OECD. The social safety net is limited, with low spending on labour markets. There are large gender gaps in employment and wages. Also, Korea has very long working hours and inflexible working-hour arrangements.

Laws have been revised to encourage working-time reduction, with the introduction of the 40-hour standard workweek in 2004 and the reduction of the limit on total weekly working hours from 68 to 52 hours in 2018. The current government has prioritized further labour market reforms to improve flexibility and protection of vulnerable social groups. The government has announced a three-pillar reform plan, which would involve more flexible working hours; a performance-based pay system; and formation of a committee find ways to manage labour market duality.

The authors of the paper note that the reduction of tax wedges can have a positive impact on output and employment, though the study does not indicate any significant effect on productivity. The impact of labour tax wedges on output and employment are more significant in periods of low growth. The study indicates that a one percentage point reduction in the labour tax wedge could increase output and employment by an average of 0.6% during recessions. Tax wedge reductions tend to have more pronounced effects in times of recession as these reforms will tend to include a fiscal stimulus that is more effective during a recession.