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Sun, December 10, 2023 | 20:30
Korea IR
More Aggressive Economic Policy Needed
Posted : 2009-02-27 00:36
Updated : 2009-02-27 00:36
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By Baek Seung-gwan
Economics Professor at Hong Ik University

The unprecedented global financial crisis has forced the Korean economy into deep trouble. It is known that there are several risk factors in the economy.


Prof. Back Seung-gwan
First, macroeconomic indicators have been rapidly deteriorating, with the growth rate turning to minus 5.6 percent in the fourth quarter of last year over the previous quarter for the first time since 1998.

Consumption and investment fell by 4.4 percent and 14 percent, respectively. Exports dropped 32.8 percent last month from the same month of the previous year, followed by a 17.9 percent decline in December of 2008. More than 100,000 jobs were lost in January, which is expected to worsen further in the coming months.

The other risk factors are the possibility of private sector defaults and banks' financial unsoundness, and the lack of foreign currency liquidity.

The government's main reaction to such risk factors is to supply more liquidity and to execute expansionary fiscal policies. First of all, however, the government must enforce more decisive and aggressive policy measures. The effectiveness of a policy package depends upon its magnitude, timing and credibility.

The fiscal stimulus package, which has been proposed up to now is worth of 51.3 trillion won, or 5.7 percent of gross domestic product (GDP), over the 2008-2012 period. It consists of corporate and personal tax cuts (35.3 trillion won) and the expansion of public expenditure (16 trillion won).

The 2009 stimulus package alone comprises 14 trillion won (1.5 percent of GDP), including 11 trillion won of public expenditure and three trillion won in tax reductions.

Contrary to Korea, the fiscal stimulus policies of other countries have been much more aggressive. The United States, which has the largest government debt in the world, has an $825 billion (5 percent of GDP) package for fiscal expansion over the next two years.
Additionally, U.S. President Obama plans further stimulus fiscal measures, including income tax refunds. The Japanese government already spent 17 trillion yen (3.3 percent of GDP) last year. Both countries also maintain a near-zero interest rate stance.

Of course, the Korean government does not need to follow policy stance of other countries. But the economic growth rate here is expected to be minus 4 percent, while those of the U.S. and Japanese economies are to contract 1.6 percent and 2.0 percent, respectively, according to the IMF.

It suggests that Korea should make more stimulus measures to revitalize domestic demand than these countries when export demand is expected to be sluggish.

The timing of policy enforcement is also important. The year 2009 is the one on which the stimulus package focuses to minimize the downturn of the Korean economy.

Many people, including professional economists, are concerned about the erosion of fiscal soundness. However, we are now confronting a ``probable'' unprecedented worldwide depression.

If the current recession seriously damages our growth potential, the cost to recover will be much larger than expected. Moreover, the government debt status is not bad. The government debt was equal to 33.3 percent of its GDP, far lower than the OECD average of 75.4 percent.

Regarding policy tools, tax reductions are more effective for short-term recovery than expanding public expenditure such as investment in infrastructure projects.

The Green New Deal projects such as revitalizing four rivers and growing forests are good for enhancing growth and creating jobs, but for the medium- and long-term.

About a week ago, Strategy and Finance Yoon Jeung-hyun announced a plan to reduce income and corporation tax rates, comparable to those of Hong Kong, starting 2010.

This proposal is desirable, but should be put into place right now. Moreover, the tax rate cut should be significant enough to affect domestic expenditure. If permanent reduction is not possible, the second best would be a temporary cut.

This time, we should also introduce tax deductions for mortgages for all households that own one house, regardless of its size. Tax deductions for mortgages lessen the debt burden of households, which allows them to spend more, and increase demand for housing. Thus, it will prevent household sector defaults due to falls in real estate prices.

On Feb. 9, Moody's Investors Service downgraded its credit ratings for eight local banks. These banks will have to pay higher premiums in borrowing overseas, worsening the shortage of foreign currency liquidity.

We should remember that the aggravation of our real economy has arisen from the frangibility of the banking sector, caused by non-performing loans to the private sector, high loan-to-deposit ratios, and the mismatch problem due to short-term funding.

It is very important to restore financial stability, which is closely related to the value of the Korean currency and the volatility of the foreign exchange market. The government plans to set up a bank recapitalization fund of 20 trillion won to secure soundness in the banking sector.

On the other hand, the U.S. Treasury Secretary Timothy Geithner announced a ``Financial Stability Plan'' worth $2 trillion on Feb. 10.

He clearly pointed out the purpose of the plan, which is to clean up and strengthen the nation's banks, bring in private capital to restart lending, and to go around the banking system directly to markets that consumers and businesses depend on.

We need to work out a comprehensive financial stability plan, too _ the sooner, the better.

But banking institutions should be recapitalized under some conditions. First, they should hold themselves accountable for irresponsible management along with structural reform.

Second, liquidity from the government should be used to generate a level of lending to consumers and firms, particularly smaller ones, greater than what would have been possible in the absence of government support.

To prevent a serious downturn of the Korean economy, the government should take more active policy measures. More domestic liquidity should be supplied to consumers and firms. More foreign liquidity should flow in the economy to alleviate the under-valuation of the Korean won and its volatility.

A current account surplus is expected this year, but not enough. The only way to have more dollars may be for our economic fundamentals including financial institutions to become strong enough to induce foreigners to invest in the domestic market.

The government is not the only one that takes responsibility for overcoming the current economic crisis, but also businesses, banks and consumers here.

Above all, what is needed right now is cooperation among political parties and a more flexible labor market.
 
wooribank
LG group
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