Abstract
This paper analyzes the implications of global rebalancing in the post-crisis period for Korea and how high leverage in the household and SMEs sectors could affect this process. The first section of the paper discusses implications of global rebalancing for Korea using simulations from the Global Integrated Monetary and Fiscal Model (GIMF). The second section focuses on how rebalancing growth in Korea is different from the rest of the region, and discusses the challenges of highly leveraged households and SMEs for the rebalancing process. The last section concludes with policy recommendations.
I. Local Challenges in global Korea: Rebalancing with Leverage1
This paper analyzes the implications of global rebalancing in the post-crisis period for Korea and how high leverage in the household and small- and medium sized enterprises (SMEs) sectors could affect this process. Unlike in some other economies, most of the region, rebalancing in Korea is not about reducing excessive current account surpluses, but finding domestic engines of growth to reduce the export dependence of the economy and improve its resilience to external shocks. In fact, consumption and investment in Korea appear in line with that of peers, but there are limits to how much they could be sustained in the post-crisis world to pick up the slack from lower external demand. To avoid the buildup of vulnerabilities from high leverage, households have to increase their saving rate limiting consumption growth. On the other hand, export-oriented and large corporates may need to invest less with lower export demand increasing corporate savings further. This would leave small and medium sized enterprises (SMEs) in the nontradable sector as the engines for investment, employment, and household income growth, increasing the urgency to address their long-standing structural problems and weak balance sheets. Delaying the necessary adjustment would increase costs and financial vulnerabilities. Improving social safety nets and the pensions system would be important to manage the adjustment costs while increasing labor market flexibility.
A. Introduction
1. The global crisis has highlighted the importance of rebalancing growth for many economies in Asia to lessen their dependence on exports, improve their resilience to external demand shocks, and sustain high growth rates in the face of waning exports to advanced economies as they repair their balance sheets.
2. Within the region, Korea stands out in many aspects. Although the Korean economy remains heavily dependent on the tradable sector, Korea’s current account surpluses have not been excessive. This is reflected in consumption and investment levels consistent with Organization for Economic Cooperation and Development (OECD) averages. This paper argues that rebalancing growth in Korea would not simply mean sustaining domestic demand growth but also shifting production, investment, and employment structures tied to export-oriented industries to nontradables. This shift would require finding new domestic engines of growth that can be financed by healthy balance sheets. However, Korean households and SMEs, the key actors to generate this shift, are highly leveraged. This could limit their ability to facilitate the new engines of growth and would require an appropriate sequencing of policies to minimize adjustment costs.
3. The first section of the paper discusses the implications of global rebalancing for Korea using simulations from the IMF’s Global Integrated Monetary and Fiscal Model (GIMF). The second section focuses on how rebalancing growth in Korea is different from the rest of the region and discusses the challenges of highly leveraged households and SMEs for the rebalancing process. The last section concludes with policy recommendations.
B. Implications of Global Rebalancing for Korea
4. Economic growth in Korea depends heavily on external demand. Although Korea’s export “exposure”—defined as the share of value added linked to external demand—at 30 percent is not one of the highest in the region and not excessive relative to the OECD, exports have remained the engine of growth contributing 68 percent to growth between 2001 and 2007. This may be surprising when contrasted with the contribution of net exports to growth in national accounts, which accounted only for 18 percent of growth in the same period, albeit well above the OECD averages. This is because the net export-based measure understates the dependence of incomes on external demand if incomes are spent on imports whereas the value added-based measure captures this effect.2 When the share of domestic investment tied to exports is also accounted for, Korea’s exposure to external demand would go up by 4 ppt to 34 percent and total contribution of export value added to growth would reach 73 percent.
Selected Asia: Export Dependence and Exposure
(In percent)
Citation: IMF Staff Country Reports 2010, 271; 10.5089/9781455204311.002.A001
Sources: Japan External Trade Organization (JETRO) Asian Input Output Table (2000); OECD; UN COMTRADE; CEIC Data Company Ltd.; Haver Analytics; and IMF staff estimates.Selected Asia: Export Dependence and Exposure
(In percent)
Citation: IMF Staff Country Reports 2010, 271; 10.5089/9781455204311.002.A001
Sources: Japan External Trade Organization (JETRO) Asian Input Output Table (2000); OECD; UN COMTRADE; CEIC Data Company Ltd.; Haver Analytics; and IMF staff estimates.Selected Asia: Export Dependence and Exposure
(In percent)
Citation: IMF Staff Country Reports 2010, 271; 10.5089/9781455204311.002.A001
Sources: Japan External Trade Organization (JETRO) Asian Input Output Table (2000); OECD; UN COMTRADE; CEIC Data Company Ltd.; Haver Analytics; and IMF staff estimates.
Selected Asia: Average Contribution to Real GDP Growth 1
(In percent of real GDP growth)
Citation: IMF Staff Country Reports 2010, 271; 10.5089/9781455204311.002.A001
1 Average of contributions to three-year growth rates between 2001-07. Exchange rate adjusted deflator.Latin America includes Argentina, Bolivia, Brazil, Chile, Colombia, Mexico, Peru, Paraguay, Uruguay, and Venezuela.Selected Asia: Average Contribution to Real GDP Growth 1
(In percent of real GDP growth)
Citation: IMF Staff Country Reports 2010, 271; 10.5089/9781455204311.002.A001
1 Average of contributions to three-year growth rates between 2001-07. Exchange rate adjusted deflator.Latin America includes Argentina, Bolivia, Brazil, Chile, Colombia, Mexico, Peru, Paraguay, Uruguay, and Venezuela.Selected Asia: Average Contribution to Real GDP Growth 1
(In percent of real GDP growth)
Citation: IMF Staff Country Reports 2010, 271; 10.5089/9781455204311.002.A001
1 Average of contributions to three-year growth rates between 2001-07. Exchange rate adjusted deflator.Latin America includes Argentina, Bolivia, Brazil, Chile, Colombia, Mexico, Peru, Paraguay, Uruguay, and Venezuela.5. Notwithstanding increasing intra-regional trade and the emergence of China as a final destination of its exports, the advanced economies remain the most important source of external demand for Korea. China is now Korea’s biggest export market (23 percent of total exports) and cyclically export growth to China was a key reason behind the rapid recovery from the Great Recession. Nonetheless, Korea lags behind Taiwan Province of China, Malaysia, Singapore, and the Philippines in benefiting from growing domestic demand in China.
Selected Asia: Share of Export Value Added in GDP
(In percent)
Citation: IMF Staff Country Reports 2010, 271; 10.5089/9781455204311.002.A001
Sources: AIO 2000; and IMF staff estimates.Selected Asia: Share of Export Value Added in GDP
(In percent)
Citation: IMF Staff Country Reports 2010, 271; 10.5089/9781455204311.002.A001
Sources: AIO 2000; and IMF staff estimates.Selected Asia: Share of Export Value Added in GDP
(In percent)
Citation: IMF Staff Country Reports 2010, 271; 10.5089/9781455204311.002.A001
Sources: AIO 2000; and IMF staff estimates.6. As a result, the deleveraging in advanced economies in the post-crisis period will mean lower external demand for Korea. Simulations with an expanded version of the IMF’s GIMF model were used to assess the implication of a rebalancing in the United States on Korea.1 A decline in external demand associated with a 2 ppt permanent increase in the U.S. private savings rate could reduce Korean exports by 6 ppt and GDP growth by 1 ppt over the next three years from their respective current IMF baseline forecasts. Furthermore, a similar rebalancing of growth in China—through lower private savings—alone will not fully offset the lack of external demand from the United States. Positive spillovers from greater Chinese demand would at best mitigate 40 percent of the adverse shock on Korea. One important reason is that, despite high growth, China has remained a marginal importer of consumer goods—accounting for only 3 percent of global imports—while the United States still dominates global imports, both in terms of direct and indirect trade linkages. At current speeds, it would take another decade for China to take over from advanced economies in leading export value added in Korea, notwithstanding the adjustment costs to reorient production to the Chinese customer basket, which is quite different than that in advanced economies.2
Export Impact from U.S. and China Rebalancing1
(Cumulative percent difference from baseline in 3 years)
Citation: IMF Staff Country Reports 2010, 271; 10.5089/9781455204311.002.A001
Source: IMF staff calculations.1/Assumes U.S. (China) private savings increase (decrease) by 2 percentage points of GDP.Export Impact from U.S. and China Rebalancing1
(Cumulative percent difference from baseline in 3 years)
Citation: IMF Staff Country Reports 2010, 271; 10.5089/9781455204311.002.A001
Source: IMF staff calculations.1/Assumes U.S. (China) private savings increase (decrease) by 2 percentage points of GDP.Export Impact from U.S. and China Rebalancing1
(Cumulative percent difference from baseline in 3 years)
Citation: IMF Staff Country Reports 2010, 271; 10.5089/9781455204311.002.A001
Source: IMF staff calculations.1/Assumes U.S. (China) private savings increase (decrease) by 2 percentage points of GDP.C. How can Korea Rebalance its Growth?
7. Despite its high export dependence, Korea has small current account surpluses, which mask shifts in underlying balance sheets of the households and corporates. Korea’s current account surplus is not excessive and, unlike most of the region, has been declining since the Asian crisis. This trend is driven by a larger decline in savings than in the region—although investment has also declined (see below). In addition, unlike most of Asia, this reflects a larger increase in corporate savings that has been largely offset by lower household savings.
Saving-Investment Balance and Current Account
(In percent of GDP; change in period averages, 2009-2001; 1996-2000)
Citation: IMF Staff Country Reports 2010, 271; 10.5089/9781455204311.002.A001
Source: WEO.Saving-Investment Balance and Current Account
(In percent of GDP; change in period averages, 2009-2001; 1996-2000)
Citation: IMF Staff Country Reports 2010, 271; 10.5089/9781455204311.002.A001
Source: WEO.Saving-Investment Balance and Current Account
(In percent of GDP; change in period averages, 2009-2001; 1996-2000)
Citation: IMF Staff Country Reports 2010, 271; 10.5089/9781455204311.002.A001
Source: WEO.8. High leverage of the household sector could limit consumption growth in the post-crisis world. Consumption growth in Korea is consistent with fundamentals and at par with peers in the OECD. However, it has been sustained by increasing debt levels, making Korean households one of the most financially leveraged, with household debt reaching 80 percent of GDP. Leverage is even higher when real wealth is considered, despite the relatively lower diversification of Korean households into financial assets. The increase in leverage has also coincided with a sharp drop in the household saving rate (see Karasulu, 2010). As the recent U.S. experience, it shows that debt-financed consumption growth cannot be sustained forever without the buildup of substantial vulnerabilities, although in Korea this is not driven by external indebtedness. This would mean that households would have to deleverage either by curtailing consumption growth or by increasing incomes or a combination of both.
Asia: Consumption Relative to Steady-State1
(In percent of GDP)
Citation: IMF Staff Country Reports 2010, 271; 10.5089/9781455204311.002.A001
1 Based on staff estimates of S-I balance using the CGER’s Macroeconomic Balance approach.2 Other emerging economies include Argentina, Brazil, Chile, Colombia, Egypt, Israel, Mexico, Morocco, Pakistan, Peru, South Africa, and Turkey.Asia: Consumption Relative to Steady-State1
(In percent of GDP)
Citation: IMF Staff Country Reports 2010, 271; 10.5089/9781455204311.002.A001
1 Based on staff estimates of S-I balance using the CGER’s Macroeconomic Balance approach.2 Other emerging economies include Argentina, Brazil, Chile, Colombia, Egypt, Israel, Mexico, Morocco, Pakistan, Peru, South Africa, and Turkey.Asia: Consumption Relative to Steady-State1
(In percent of GDP)
Citation: IMF Staff Country Reports 2010, 271; 10.5089/9781455204311.002.A001
1 Based on staff estimates of S-I balance using the CGER’s Macroeconomic Balance approach.2 Other emerging economies include Argentina, Brazil, Chile, Colombia, Egypt, Israel, Mexico, Morocco, Pakistan, Peru, South Africa, and Turkey.
Debt as a Percent of Net Wealth 1/
Citation: IMF Staff Country Reports 2010, 271; 10.5089/9781455204311.002.A001
Sources: OECD; and IMF staff estimates.1/Net wealth is defined as nonfinancial and financial assets minus liabilities. For Japan and Germany the latest observation is 2007 and for UK 2008.Debt as a Percent of Net Wealth 1/
Citation: IMF Staff Country Reports 2010, 271; 10.5089/9781455204311.002.A001
Sources: OECD; and IMF staff estimates.1/Net wealth is defined as nonfinancial and financial assets minus liabilities. For Japan and Germany the latest observation is 2007 and for UK 2008.Debt as a Percent of Net Wealth 1/
Citation: IMF Staff Country Reports 2010, 271; 10.5089/9781455204311.002.A001
Sources: OECD; and IMF staff estimates.1/Net wealth is defined as nonfinancial and financial assets minus liabilities. For Japan and Germany the latest observation is 2007 and for UK 2008.9. The structure of household lending has limited financial risks but increased consumption volatility. In fact only about one-third of household debt in Korea is tied to residential mortgages (two-thirds in the OECD on average) and strict loan-to-value and debt-to-income-regulations limit excessive leveraging through home ownership.3 Nonetheless, 90 percent of household loans are at floating market interest rates making household consumption more vulnerable to interest rate shocks and the business cycle.4 As a result—and despite wider access to finance—consumption volatility has increased three-fold since 1998, and rather than smoothing aggregate activity, consumption now amplifies its volatility.
Growth, Private Consumption and Saving Rate
(y-o-y growth, percent)
Citation: IMF Staff Country Reports 2010, 271; 10.5089/9781455204311.002.A001
Source: CEIC Data Company Ltd.Growth, Private Consumption and Saving Rate
(y-o-y growth, percent)
Citation: IMF Staff Country Reports 2010, 271; 10.5089/9781455204311.002.A001
Source: CEIC Data Company Ltd.Growth, Private Consumption and Saving Rate
(y-o-y growth, percent)
Citation: IMF Staff Country Reports 2010, 271; 10.5089/9781455204311.002.A001
Source: CEIC Data Company Ltd.10. Consumption growth will depend on the amount of leverage that can be sustained by households. Finding the optimal nexus of consumption and leverage for the household sector is not straightforward and would depend on the extent to which the buildup has reflected structural and cyclical factors, such as financial deepening and a low interest rate environment, and the degree to which the substantial increase in households’ gearing has been excessive and needs to be unwound. Nonetheless, a simple model of household debt dynamics can be used to demonstrate the unsustainability of the current path. Assuming an effective nominal interest rate on existing household debt of 6 percent and a future nominal growth rate of disposable income of 6 percent—both reflecting recent averages—debt-to-income ratio would stabilize around the current 140 percent. However, regulatory tightening globally and in Korea and a gradual return to neutral interest rates are expected to increase carrying cost of debt and limit credit growth forcing deleveraging. A gradual 200 bps increase in interest rates from this baseline by 2013 and a decline in the debt-to-income ratio to 100 percent by 2030 would require households to spend an improbable 70 percent of projected disposable income by 2030 on debt repayments leaving little to consume. Obviously, these numbers are illustrative and meant to demonstrate the potential constraints on consumption growth even a gradual deleveraging would entail. Even in the absence of deleveraging, sustaining consumption growth with higher carrying costs would be difficult and would act as a medium-term drag on overall economic activity, but especially on SMEs, who depend more on domestic demand.
Scenario Analysis: Gradual Deleveraging
Citation: IMF Staff Country Reports 2010, 271; 10.5089/9781455204311.002.A001
Source: CEIC Data Company Ltd.Scenario Analysis: Gradual Deleveraging
Citation: IMF Staff Country Reports 2010, 271; 10.5089/9781455204311.002.A001
Source: CEIC Data Company Ltd.Scenario Analysis: Gradual Deleveraging
Citation: IMF Staff Country Reports 2010, 271; 10.5089/9781455204311.002.A001
Source: CEIC Data Company Ltd.11. The adjustment of households’ balance sheet is unlikely to be uniform across households as the most rapid debt growth has been registered at the top and bottom income levels. While high income households seem to have borrowed heavily to invest in real estate, low-income households tend to do so for consumption. It is estimated that more than 13 percent of households in the bottom 20 percent income group have debt payments over 40 percent of their income (Hahm, et al. 2009). To the extent low-income groups tend to have a higher marginal propensity to consume, the impact of deleveraging on aggregate consumption could be even higher.5
Household Saving Rate and Leverage By Income Quintile
(As a percent of disposable income)
Citation: IMF Staff Country Reports 2010, 271; 10.5089/9781455204311.002.A001
Sources: Korea National Statistics Office; and Hahm et al. (2009).Household Saving Rate and Leverage By Income Quintile
(As a percent of disposable income)
Citation: IMF Staff Country Reports 2010, 271; 10.5089/9781455204311.002.A001
Sources: Korea National Statistics Office; and Hahm et al. (2009).Household Saving Rate and Leverage By Income Quintile
(As a percent of disposable income)
Citation: IMF Staff Country Reports 2010, 271; 10.5089/9781455204311.002.A001
Sources: Korea National Statistics Office; and Hahm et al. (2009).12. Slower export growth in the post-crisis period could also limit domestic investment. While current aggregate investment levels in Korea are close to their long-term average and still high by developed country standards investment growth since the Asian crisis has been driven by larger companies, who also dominate Korea’s exports. 6 Slower export growth in the post-crisis world could lead large cooperates to reduce domestic investment, even as they increase FDI to the region to benefit from lower labor costs elsewhere.
Capital-to-Output and Investment-to-Output Ratio
(Relative to steady-state level in 2008)
Citation: IMF Staff Country Reports 2010, 271; 10.5089/9781455204311.002.A001
Sources: Penn World Tables; IMF, WEO database; and staff calculations.Capital-to-Output and Investment-to-Output Ratio
(Relative to steady-state level in 2008)
Citation: IMF Staff Country Reports 2010, 271; 10.5089/9781455204311.002.A001
Sources: Penn World Tables; IMF, WEO database; and staff calculations.Capital-to-Output and Investment-to-Output Ratio
(Relative to steady-state level in 2008)
Citation: IMF Staff Country Reports 2010, 271; 10.5089/9781455204311.002.A001
Sources: Penn World Tables; IMF, WEO database; and staff calculations.13. The only offsetting factor would be investment by domestically oriented companies, the majority of which are SMEs. However, unlike the chaebol, the SMEs have lagged behind, largely reflecting weaker fundamentals in the aftermath of the Asian crisis. Small firms also tend to dominate the services sector (representing around 85 percent of firms), where productivity growth has been lackluster7. Looking ahead, a vibrant SME sector, especially in the nontradable secto, will be vital for investment growth and sustaining high rates of growth. With thei decades’ long focus on export-oriented manufacturing, large corporates do not have the experience or the incentives to invest in services. In addition, should they reorient themselves to the nontradable sector, this could have implications for domestic competition policy.
Facility Invesment
(1990=100)
Citation: IMF Staff Country Reports 2010, 271; 10.5089/9781455204311.002.A001
Sources: The Federation of Korean Industries; and IMF staff estimate.Facility Invesment
(1990=100)
Citation: IMF Staff Country Reports 2010, 271; 10.5089/9781455204311.002.A001
Sources: The Federation of Korean Industries; and IMF staff estimate.Facility Invesment
(1990=100)
Citation: IMF Staff Country Reports 2010, 271; 10.5089/9781455204311.002.A001
Sources: The Federation of Korean Industries; and IMF staff estimate.
Debt Ratio and Ordinary Income to Sales
(In percent)
Citation: IMF Staff Country Reports 2010, 271; 10.5089/9781455204311.002.A001
Source: BOK Financial Statement Analysis.Debt Ratio and Ordinary Income to Sales
(In percent)
Citation: IMF Staff Country Reports 2010, 271; 10.5089/9781455204311.002.A001
Source: BOK Financial Statement Analysis.Debt Ratio and Ordinary Income to Sales
(In percent)
Citation: IMF Staff Country Reports 2010, 271; 10.5089/9781455204311.002.A001
Source: BOK Financial Statement Analysis.14. However, the rapid expansion of credit guarantees for SMEs after the Asian crisis and the Great Recession have held back needed restructuring. Between 1997-2001, SME credit guarantees roughly doubled in size, reaching a peak of nearly 8 percent of GDP, compared to only 1.5 percent of GDP in Taiwan Province of China, 0.2 percent in the United States and 0.6 percent in France. Unwinding such support has also proven difficult. The size and coverage were only partially pared back during the subsequent recovery, and rose again following the Great Recession, reaching 6 percent of GDP (the highest in non-Japan Asia). In addition to expanding the size of guarantees, their coverage was also increased and terms made more generous, although the authorities are in the process of scaling them back to pre-crisis levels.
SME Guarantees
(In percent of GDP)
Citation: IMF Staff Country Reports 2010, 271; 10.5089/9781455204311.002.A001
Source: IMF staff estimates.SME Guarantees
(In percent of GDP)
Citation: IMF Staff Country Reports 2010, 271; 10.5089/9781455204311.002.A001
Source: IMF staff estimates.SME Guarantees
(In percent of GDP)
Citation: IMF Staff Country Reports 2010, 271; 10.5089/9781455204311.002.A001
Source: IMF staff estimates.15. Furthermore, SME guarantees favor repeat clients and do not provide incentives to banks to develop new instruments suitable for the SMEs in the services sector. Given the high degree of coverage, Korean banks tend to direct loans to those SMEs that can secure credit guarantees which overwhelmingly are well established firms.8 Although these guarantees are typically given for only one year, they are usually rolled over, or were required to be rolled over following the global crisis. Therefore, the bulk of guarantees outstanding are directed toward existing firms, creating a barrier to new entrants. As a result, low profitability of existing SMEs and the financing constraints for the newcomers limit their ability to invest.
16. In addition to the guarantees, policy support to SMEs through other channels is sizable. Besides the loans of the dedicated policy banks (IBK and KDB) and the government-run Small Business Corporation, SMEs also benefit from regulatory lending recommendation on banks. 9 Domestic banks are strongly recommended to allocate a certain portion of their won loan book to SMEs. Commercial banks are recommended to keep this portion above 45 percent and for regional banks the recommended target is 60 percent. Foreign branches are recommended to keep it above 25 or 35 percent, depending on their use of the Bank of Korea (BOK)’s discount window. For mutual savings banks and credit specialized financing companies,10 loans to SMEs must be between 30 to 50 11 percent of total outstanding loans. In addition, the BOK operates a credit facility at favorable terms for on-lending to SMEs.
17. The prospects of households are closely tied with SMEs, especially in the nontradable sector. The distinction between households and “mom and pop” shops is blurred as 88 percent of companies operate as micro-enterprises.12 SMEs dominate the services sector and depend on domestic consumption more than the large firms, tying closely investment in the sector with employment growth. This suggests that addressing SMEs weaknesses in the services sector would go a long way supporting household income growth and deleveraging.
SMEs, Employment and Domestic Demand
(y/y percent change)
Citation: IMF Staff Country Reports 2010, 271; 10.5089/9781455204311.002.A001
Source: CEIC Data Company Ltd.SMEs, Employment and Domestic Demand
(y/y percent change)
Citation: IMF Staff Country Reports 2010, 271; 10.5089/9781455204311.002.A001
Source: CEIC Data Company Ltd.SMEs, Employment and Domestic Demand
(y/y percent change)
Citation: IMF Staff Country Reports 2010, 271; 10.5089/9781455204311.002.A001
Source: CEIC Data Company Ltd.18. Cognizant of the need to rebalance growth toward the nontradable sector, the authorities launched a major initiative in May 2009 to develop services. As part of its strategy to create new “engines of growth,” the government identified 9 service sectors, including education, content provision, IT services, design consulting, medical services, employment support, logistics, and broadcasting and communications. However, the choice was based on their potential to reduce Korea’s deficit in service trade and the sectors’ value added, rather than addressing the broader problems in the SMEs and the services sector. The plan targets a more level playing field between services and manufacturing by increasing the tax incentives, fiscal aid, and SME support to the level of manufacturing. For example, knowledge-based services are being given more government credit guarantees and to increase the amount of SME assistance received in the service sector, the government greatly relaxed the requirements for service firms to be classified as SMEs.13
D. Conclusions and Policy Recommendations
19. Rebalancing growth from exports to the nontradables with leveraged actors will require action on multiple fronts and a careful balancing act. Delaying SME restructuring would undermine a sustained increase in investment and employment growth in the nontradable sector and feed the incentives for more leverage. Efforts to restructure SMEs should start with scaling back SME guarantees back to international norms, while resisting temptations to use industrial policy for the new engines of growth in the nontradable sector. At a minimum, the regulatory requirements to lend to SMEs should be gradually eliminated to encourage banks to assess risks and opportunities and improve the efficiency of capital
20. Leveling the playing field between services and manufacturing would be crucial in rebalancing and sustaining growth. However, this would be better achieved by reducing support to the latter, rather than, as planned, extending more government guarantees and payments to service firms, notably SMEs. Rather than service industry-specific measures, broader policies to strengthen competition in services by eliminating domestic entry barriers, accelerating regulatory reform, upgrading competition policy and reducing barriers to trade and inflows of foreign direct investment (FDI) would be needed to improve productivity in services.
21. Maintaining a robust consumption growth while avoiding an abrupt deleveraging of households will require a combination of policies to support incomes, ease transition costs, and further develop the financial sector to better intermediate the risks now born by households. A carefully planned sequencing of labor market policies and increased social protection for unemployed would be crucial to minimize the adjustment costs until restructuring of the SMEs can unleash new sources of employment and income growth (Eskesen, 2010). Addressing the seniority system in the labor market, while increasing the coverage of and the contribution to the pension system would improve formal employment opportunities for the aging population and support household incomes. Developing mortgage financing further and addressing the structural problems in the housing sector would also go a long way in addressing the financial risks inappropriately born by the households who cannot diversify them.
References
Chensavasdijai, V., 2006, Korea’s Transition to a Knowledge-Based Economy: Prospects and Challenges Ahead, IMF Staff Country Report 06/381 (Washington:.International Monetary Fund).
Eskesen, L., 2010, Labor Market Dynamics in Korea—The Role of Institutions and Shocks, IMF Staff Country Report (forthcoming).
Frydl, E., 2007, The Mortgage Market in Korea: Financial Risks and Development Needs, IMF Staff Country Report 07/345 (Washington:.International Monetary Fund).
Feyzioğlu, T, M. Skaarup, and M. Syed, 2008, “Addressing Korea’s Long-Term Fiscal Challenges,” IMF Working Paper No. 08/27 (Washington:.International Monetary Fund).
Hahm, Joon-Ho, Chung-In Kim and Young-Sook Lee, 2009, “Risk Assessment of Korean Household Debts and Implications for Macro Prudential Regulations,” (in Korean), Policy Symposium, November 25, 2009, mime.
Hüfner, F., and I. Koske, 2010, “Explaining Household Saving Rates in G7 Countries: Implications for Germany,” OECD Economics Department Working Paper No. 754.
International Monetary Fund, Regional Economic Outlook: Asia and Pacific, April 2010 “Leading the Global Recovery: Rebalancing for the Medium Term,” (Washington: International Monetary Fund). http://www.imf.org/external/pubs/ft/reo/2010/APD/eng/areo0410.htm
Kang, K. and Song-Yi Kim, 2006, A Strategy for Restructuring the SME Sector in Korea, IMF Staff Country Report No. 06/381: http://www.imf.org/external/pubs/cat/longres.cfm?sk=20038.0
Karasulu, M., 2008, Stress Testing Household Debt in Korea, IMF Staff Country Report No. 8/296,: http://www.imf.org/external/pubs/cat/longres.cfm?sk=22349.0
Karasulu, M., 2010, Are Korean Households Saving too Little?, IMF Staff Country Report (forthcoming).
Kwack, S.Y., and Y.S. Lee, 2005, “What determines saving rates in Korea? The role of demography,” Journal of Asian Economics, 16, 861–73.
Lee, J.E, and Y.D. Kim, 2010, “Impact of Loan-Deposit-Ratio Caps on Korea’s Financial markets,” KIF Finance VIP Series.
Muellbauer, J., 1994, The Assessment: Consumer Expenditure, Oxford Review of Economic Policy, 10, Issue 2, p. 1–41, http://econpapers.repec.org/RePEc:oup:oxford:v:10:y:1994:i:2:p:1-41.
N’Diaye, P. Zhang W., Zhang, 2010, “Structural Reform, Intra-regional Trade, and Medium-term Growth Prospects of East Asia and the Pacific-Perspectives from a New Multi-region Model,” Journal of Asian Economics, 2120–36.
OECD (2010), Economic Review-Korea: http://www.oecd.org/document/24/0,3343, en 2649_34569_ 45393816 _1 _1_ 1_ 1,00.html
Syed, M., 2008, What Determines Investment in Korea?, IMF Staff Country Report No. 08/296 (Washington: International Monetary Fund). http://www.imf.org/external/pubs/cat/longres.cfm?sk=22349.0
Prepared by Meral Karasulu; Janice Lee provided assistance with data. An earlier version of this paper is expected to be published in the Korea and World Economy Journal.
Export-based measures will also overstate the role of exports as a source of growth, as increasing vertical trade integration means that exports include a declining share of domestically produced value added. Asian international input-output (AIO) tables were used to measure the extent to which the value added produced in an economy can be attributed to domestic, intraregional, and extra-regional demand. For details see Regional Economic Outlook, April 2010: http://www.imf.org/external/pubs/ft/reo/2010/APD/eng/areo0410.htm
For technical details of the model see N’Diaye et al. (2010). Simulations are from Regional Economic Outlook, April 2010.
Measured by an import similarity index based on SITC-5 digit data comprising over 300 line items for consumer goods, the consumer goods basket imported by China overlaps by only about 35 percent with that in other advanced economies.
See Frydl (2007) for a discussion of the mortgage markets in Korea.
In the United States (2005), EU (2004) and United Kingdom (2004) variable rate mortgages constituted 31, 46 and 72 percent of all mortgages, respectively. The loan-to-values (LTV) in Korea have been declining against the global trend, going down from 56.4 at end-2004 to 47 at end-2007. The global average is 80 percent.
Karasulu (2008) estimates that low-income groups’ propensity to consume out of current period income is about five times as high as that of the overall population.
Pre-1998 investment levels were at historic highs despite relatively subdued corporate indicators, and are difficult to rationalize based on economic fundamentals. See Syed (2007).
Productivity in services in Korea is relatively low at 58 percent of the manufacturing and 44 percent of the U.S. service sector. For a deeper discussion of problems in the services sector see Chensavasdijai (2006).
While more than 70 percent of KCGF guarantees have a one-year maturity, the typical firm has been under Korea Credit Guarantee Fund’s (KCGF) coverage for five years. More than 30 percent of Korea Technology Finance Corporation’s (KOTEC) guarantees went not to start-ups but to established companies older than three years.
Lee et al. (2009) estimate that the share of total policy support to SMEs constitutes 30 percent of their funding, while bank loans (with or out without guarantees) account for 62 percent.
Credit-specialized financial companies (CSFCs) consist of credit card companies, leasing companies, installment finance companies, and new technology-venture capital companies.
For mutual saving banks, the requirement encompasses household loans as well.
As a result, reported SME loans, which rely only on commercial bank data, appear to underestimate SME debt by about 30 percent while misclassification overstates household loans.
OECD, 2010 Economic Review-Korea.
