KDI - Korea Development Institute - RESEARCH - Economic Outlook

Summary

KDI Economic Outlook 2024-1st Half High Inflation and Consumption Stagnation: Focusing on the Relative Price between Income and Consumption

■ In South Korea, real private consumption appeared lethargic in 2023 due to the stagnation in real purchasing power, driven by a sharp rise in consumer prices (3.4%) and a decline in the real economic growth rate (1.4%).

- In both 2022 and 2023, the growth rate of real purchasing power stagnated due to falling real income relative to consumption. This slump resulted from the sharp rise in international oil prices in 2022 and the marked decline in semiconductor prices in 2023.

- Additionally, the steep upward trend in consumer prices triggered the adoption of a high-interest rate policy, further exacerbating sluggish private consumption (see Current Affairs I).

■ Going forward, the conditions for real private consumption are projected to gradually improve as the real economic growth rate expands and the value of income relative to consumption increases.

- A majority of forecasting agencies project the economic growth rate to rise to the mid-2% range in 2024, bolstered by a rapid increase in exports, higher than the 2023 figure (1.4%).

- Furthermore, in 2024, the capacity to spur private consumption is expected to experience meaningful expansion as real purchasing power substantially improves due to the marked rise in semiconductor prices.

- However, high interest rates, outside the purview of this report, are still expected to act as a delaying factor for the recovery of private consumption.

■ Therefore, it is assessed that the current situation does not require short-term macroeconomic policies to stimulate private consumption.

- Given the high probability of gradual moderation in consumption stagnation propelled by improving real purchasing power, it is not advisable to consider stimulus measures as requiring urgent action. It is also noteworthy that such policies could disrupt the ongoing trend toward inflation stabilization, potentially delaying interest rate cuts.

- In addition, given that the trends of private consumption and income eventually sync up, the policy focus should be structural reforms that improve income-generating capacity by boosting medium- to long-term economic dynamism.

Summary

KDI Economic Outlook 2024-1st Half Weather Condition Changes on Prices: Effects and Implications

■ Weather shocks raise consumer prices in the short term, primarily affecting fresh food prices. However, their impact on core prices appears marginal.

- Among various types of weather shocks, precipitation has a greater impact on prices compared to temperature, especially during summer.

- As global warming increases summer temperatures and intensifies weather volatility both in frequency and severity, such as through heavy rainfall and droughts, short-term price instability, especially for fresh food, may become more prevalent.

■ Despite the initial divergence between consumer and core prices, driven by volatile prices for food (fresh food) and energy, consumer prices tend to revert to core price levels over the medium term.

- This observation suggests that although temporary spikes in fresh food prices can elevate consumer prices in the short term, they have little impact on the underlying price trend.

■ Therefore, it is not advisable for monetary policy to sensitively respond to short-term fluctuations in fresh food prices.

- To reduce the impact of localized weather shocks on consumer prices, it would be prudent to explore structural measures, such as diversifying supply sources by increasing agricultural imports.

- In addition, strengthening climate resilience through measures like crop variety improvement is necessary to prepare for and mitigate the effects of climate change.

Summary

KDI Economic Outlook 2023-2nd Half The Rising Labor Participation of Women in Their 30s: Underlying Factors and Implications

■ The upward trend in the labor force participation rate among women in their 30s is closely linked to the declining proportion of women with children within this age bracket.

■ Currently, the reduction in the number of women in their 30s with children is mitigating the slowdown in labor supply. However, over time, it could result in a shrinking working-age population and labor force, exacerbating economic and societal challenges.

- Over the next five years (2024-2028), anticipated demographic changes, including a declining working-age population and aging, are forecasted to reduce the number of employed individuals by 30,000 to 40,000 annually. On the other hand, the rising labor force participation rate among women in their 30s is expected to bolster the employment numbers by approximately 40,000 each year, counteracting the effects of these demographic shifts.

- However, the economic participation of women in their 30s is on the rise coinciding with a deepening trend of low birth rates (the total fertility rate declining to 0.7 in the second quarter of 2023). In the long run, this poses alarming concerns regarding economic slowdown, pension fund stability, and deteriorating fiscal health for the government.

■ To address the observed trends and challenges, sustained policy support for work-family balance is essential to simultaneously boost both the labor force participation and birth rate of women during their childbirth and child-rearing years.

- While there appear to be considerable advancements in conditions that support the economic activities of women with children, child-rearing remains a chief deterrent to women’s workforce participation.

- It is essential to further develop and widely promote measures that support work-family balance, including options for reduced work hours during child-rearing phases and flexible work arrangements, alongside fostering a more universally family-friendly workplace culture.

- In addition, it is vital to strengthen economic self-sufficiency and accelerate the transition to family life for younger adults by enhancing their engagement in economic activities, which requires creating high-quality job opportunities to improve their current employment rates that lag behind those of major economies.

Summary

KDI Economic Outlook 2023-1st Half Semiconductor Market Trends and Macroeconomic Implications

■ Korea's semiconductor exports have been heavily concentrated in the highly volatile memory sector, making the industry more vulnerable to downturns.

- As of 2022, the proportion of the highly volatile memory semiconductor sector within Korea's semiconductor market was more than twice that of the global market. This discrepancy may have contributed to the 9.5%p decline in semiconductor exports during Q1.

- Despite the growing investment in non-memory semiconductors since 2018, Korea's semiconductor industry continues to exhibit a significant reliance on the memory sector, leading to persistently high levels of volatility in semiconductor exports.

■ The trajectory of the semiconductor industry is shrouded in uncertainty, but certain indicators suggest a potential trough might occur between Q2 and Q3.

- The latest replacement cycles of semiconductor-related products, coupled with the trends in production and inventory cycles, hint that the semiconductor industry may be approaching a trough.

- A deceleration in the semiconductor economy is likely to exert a negative impact not only on exports but also on domestic demand via income channels. This slowdown may lead to deteriorating tax revenue conditions in 2023-2024.

- However, given the relatively modest employment multiplier effect of the semiconductor industry, the repercussions on the labor market are expected to be minimal.

■ Elevating the share of the non-memory sector could contribute to reducing economic fluctuations. In addition, concerted efforts are needed to mitigate the spillover effect of intensifying geopolitical risks in recent times.

- Acknowledging the growing macroeconomic significance of the semiconductor industry, the recent diversification towards increasing the investment in the non-memory sector can be viewed positively from a standpoint of economic stability.

- Conversely, the semiconductor industry's high susceptibility to geopolitical risks, particularly in the context of the escalating US-China conflict, underscores the critical need to strengthen industrial, trade, and diplomatic leadership strategies to mitigate uncertainties in associated sectors.

Summary

KDI Economic Outlook 2023-1st Half Recent Fluctuations in Current Account: Factors and Implications

■ The analysis results show that the recent decline in the current account balance was driven by a sustained increase in expenditure despite a decline in income due to deteriorating external conditions.

- The decline in the current account in 2H 2022 was largely due to a decrease in income caused by the decline in the terms of trade, with some contribution from domestic demand.

- In 2023, the current account surplus is expected to narrow to 1.0% of GDP as domestic demand maintains a relatively high increase amid the persistent global economic slowdown.

■ Given the current status of external soundness of the Korean economy, a sharp contraction in the foreign exchange market due to a decline in the current account is unlikely to occur.
- Currently, Korea’s foreign exchange reserves and net foreign assets are significantly different in size from those of countries that have experienced foreign exchange crises in the past, and even if the current account decline persists for one or two years, the likelihood of a foreign exchange crisis due to a decline in net foreign assets appears to be low.

■ Therefore, it is advised that the macroeconomic policy stance should not be sensitive to short-term fluctuations in the current account.

- It is important to note that the narrowing of the recent trade deficit may not guarantee macroeconomic stability.

- Consequently, when assessing the current situation and setting a policy framework, it is necessary to pay close attention to indicators closely related to macroeconomic conditions, such as prices, economic activity, and employment, rather than short-term fluctuations in the current account.

Summary

KDI Economic Outlook 2023-1st Half The Impact of Rising Interest Rates on Housing Construction and Outlook

■ The rate hike has contributed to the reduction in housing prices and starts and is anticipated to result in a decline in future housing construction, ultimately weakening economic growth.

- The analysis found that the decline in housing starts, due to high interest rates, is projected to hinder economic growth by 0.3%p in 2023 and 0.4%p to 0.5%p in 2024.

■ Recent rate hikes are intentionally designed to control inflation by managing economic growth at a slower pace, with the decline in the housing economy being understood as part of that process.

- The current tight monetary policy stance aims to stabilize inflation despite the broader economic slowdown.

- With low-interest rates in 2020 and 2021, real transaction prices of apartments soared by 16.7% and 18.1%, respectively, and are now entering a correction period.

- With the recent timing of rate hikes, the housing market encountered credit crunches centered on real estate PFs, exacerbating the challenges faced by construction companies. However, the need for policy response is not urgent unless the risk of a financial system crisis escalates.

■ Nevertheless, if housing construction stays contracted for a significant period of time in the future due to the recent decline in housing prices, a shortage of housing supply may arise, necessitating ongoing efforts to enhance housing supply resilience to demand changes.

- Housing supply takes considerable time, and mismatches between supply and demand often occur. It is essential to create conditions that can support housing supply, such as through public residential sites preparation, when housing demand begins to recover.

- Simultaneously, due to rising construction costs, construction companies and homeowners' associations frequently engage in conflicts, causing delays in construction. Relevant systems must be overhauled for improvement to ensure construction projects are executed as planned.

Summary

KDI Economic Outlook 2023-1st Half The Impact of Rate Hikes on Young Adults’ Debt and Consumption: Implications for Policy

■ Rising interest rates disproportionately lowered consumption among young adults compared to middle-aged and older adults, with larger decreases observed for young adults with higher levels of debt, lower income, or weaker credit ratings.

- Those in their 20s reduced their consumption by approx. 299,000 won (1.3%), which is 8.4 times larger than the decrease of 36,000 won (0.2%) among older adults in their 60s.

- Young adults with debt in the top half experienced a consumption decrease (264,000 won, 1.1%) that was about 11 times greater than that of those without debt (24,000 won, 0.1%).

- Among the top 50% of debt-burdened young adults, those with low credit scores (700 and below) reduced their consumption by a noteworthy 539,000 won (2.2%) per year for a 1% increase in the base rate.

■ Policy makers should continue their efforts to assist younger borrowers in managing their debts at sustainable levels.

- Loan regulations, such as DSR, should account for the current and future income of young adults, considering their potential income growth over the life cycle.

- Since a considerable share (around 85%) of young adults’ debt is tied to housing, concurrent policy efforts to stabilize housing costs are crucial for managing their debt in a sustainable manner.

■ It is essential to offer young borrowers in marginal situations additional opportunities to refinance their existing debt into longer-term amortizing loans. This can help alleviate their debt burden, enabling them to gradually repay their obligations over an extended period of time.

- Given the lengthy remaining work period of young adults, facilitating debt repayment over an extended period could mitigate the risk of a sudden deterioration in debt structure. This approach would help prevent precarious financial behaviors, such as engaging in a ‘rob Peter to pay Paul’ strategy.

Summary

KDI Economic Outlook 2022-2nd Half Long-term Economic Growth: Projection and Implications

■ According to the analysis, the declining growth rate of the Korean economy since the global financial crisis was mainly attributable to the slowdown in productivity improvement.

- During 2001~10, the slowdown in capital supply growth was the main driver of falling economic growth.

- In comparison, the contribution of labor supply to growth remained relatively steady in 1991~2019.

■ It is projected that the economic growth rate of Korea will slump to 0.5% in 2050 as the growth starts to slow gradually from the 2020s due to demographic changes like population decline and rapid population aging.

- In 2050, the per capita GDP growth rate is expected to stand at 1.3% due to the accelerating pace of population aging, which causes decreasing working-age population and an increasing share of the elderly with low labor force participation.

- This long-term growth projection is based on the premise that Korea’s productivity will maintain a 1% growth after a partial rebound from its lowest (0.7%) in 2011~19.

- Meanwhile, the potential growth rate of the Korean economy will reach a 2.0% level over the next five years (2023~27).

■ The Korean economy needs to mitigate the negative impacts of demographic changes by actively pushing for structural reforms to enhance productivity.

- Institutional reforms in trade openness and regulatory rationalization aiming to boost Korea’s economic vibrancy are necessary to achieve higher productivity.

- Employment conditions should improve to facilitate the active participation of women who, despite high productivity, typically stay out of the labor force due to childbirth and rearing, as well as elderly citizens whose share is rapidly increasing. Also, a reduction in labor supply needs to be countered by actively accepting foreign workers.

- At the same time, continued policy efforts are needed, with a particular focus on improving the qualitative capability of human capital through educational reforms.

■ Furthermore, the stance of macroeconomic policy needs to reflect the slowing pace of the long-term economic growth.

- While efforts to strengthen the growth potential are of reasonable necessity, the government should not be myopic and focus only on short-term stimulus in seeking a goal that greatly exceeds its growth potential.

Summary

KDI Economic Outlook 2022-2nd Half Increase in the Number of Employed Persons: Assessment and Projection

■ Unprecedented gains in the recent job market can be mainly attributable to the higher labor demand related to non-face-to-face services and the digital economy resulting from responses and adaptations to the pandemic crisis.

- The COVID-19 pandemic dealt a severe blow to employment in face-to-face services but expedited the transition into a non-face-to-face economy and the Fourth Industrial Revolution, creating jobs in the related sectors.

■ While the labor market will remain robust into 2023, the growth of the number of employed persons will decline sharply to 84,000 in 2023 from 791,000 in 2022 as shifting population structures cut down the employment number, and the base effect kicks in.

- The number of employed persons is likely to significantly narrow its gain in 2023 owing to the base effect. Still, the employment rate, which reflects the change in employment conditions, is expected to keep favorable contributions at about 102,000.

- However, structural changes in demographics, such as the share of the working-age population and age distribution, are expected to bring down the number of employed persons (-18,000) with more explicit negative impacts on labor supply.

- The percentage of the prime-age population (30~59) will continue to fall, and the share of the working-age population (15+) will shift to decrease. Accordingly, such a structural change in the population is expected to be the leading cause of the slowdown in the number of employed persons.

■ Since a fall in labor input risks a decline in Korea's economic growth, policy efforts are required to boost the labor supply.

- In parallel with enhancing the use of an underutilized workforce of women, young seniors, and foreigners, policy efforts should aim to raise the birth rate in the longer term.

- On top of expanding the quantity of labor supply, there should be a human capital development system that can improve labor productivity and promptly respond to rapidly changing labor demand.

Summary

KDI Economic Outlook 2022-2nd Half Impacts of Currency Fluctuations on Exports and Imports and the Trade Balance

■ This study finds that the weakening of the Korean won reduces import value temporarily and, in the mid-term, expands export value, narrowing the trade deficit.

- Since the US dollar is the usual choice for payment in international trade, the depreciating won has little impact on export volume in the short term. In contrast, import volume plunges due to the rising import value (in terms of the Korean won).

- In the medium term, as product prices are gradually adjusted, the weaker Korean won has a growing impact on the volume of imports.

■ While the recent rise of the dollar has caused a short-term increase in the trade deficit, the analysis shows that the rising rate of won/dollar has partially offset the deficit.

- The dollar rally in Q2 and Q3 this year brought about a contraction in overall trade, expanding Korea’s trade deficit by $6 billion for the said period.

- On the other hand, the rising won/dollar rate is estimated to offset the trade deficit by $2 billion during that period.

- Price adjustment via increasing the won/dollar rate progresses gradually, and the recent strength of the dollar is estimated to reduce the trade deficit by $6.8 billion in the next two years.

■ Fluctuating exchange rates can affect the economy through various channels, and this study reaffirms that currency fluctuations function to mitigate trade imbalance.

- Monetary policies appropriate for the macroeconomic conditions of each country cause exchange rates to move, alleviating imbalances between countries.

- Accordingly, the currency rate should be allowed to float in line with the supply and demand of the foreign exchange market as long as it operates smoothly and stably.

■ In addition to macroeconomic stability, policy efforts should also seek to protect vulnerable people in economic hardship due to soaring import prices in the dollar rally.

- With persistent high inflation, rising prices of items like petroleum products, electricity, and gas, closely tied to import prices, may put further pressure on the vulnerable.

- As sweeping policy support for the vulnerable risks conflicts of interest with the policy effort to tame high inflation, policy protection for vulnerable groups should look for ways to provide selective assistance.

■ To enhance the macroeconomic stabilization of foreign exchange rates in the longer term, an environment conducive to wider use of Korean won in international transactions in goods should be promoted.

- When international transactions are settled mostly in dollars, the short-term effect of currency fluctuations on exports is insignificant, thus limiting the adjustment of trade imbalance.

- In the medium to long run, the government should work to lay the ground for the Korean won to serve as a settlement currency in international trade by strengthening its macro-prudentiality and enhancing the financial and foreign exchange market systems.

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