By Kim Jae-kyoung
Staff Reporter
Three ``evil'' forces ― a negative wealth effect, the credit crunch and massive layoffs ― are combining to unsettle the economy.
Stock investors sustained 160 trillion won in paper losses last year, triggering a negative wealth effect, which has the chain effect of reducing consumption, production and employment.
This effect has also triggered the credit crunch, making banks reluctant to lend more to individuals and businesses because of their reduced capability to repay debts.
``The main cause of the credit crunch is that potential borrowers are not creditworthy. Their collateral value and income have declined,'' Andy Xie, a former Morgan Stanley economist, said in a recent article.
Finally but most importantly, soaring job losses have severely contracted domestic demand, signaling that the economy will undergo a more painful, longer recession than was widely anticipated.
The worsening job market is particularly worrisome as it hampers consumer spending and business investment, which will in turn hurt banks' balance sheets further.
The sharp fall in manufacturing output growth in the fourth quarter has started triggering an employment collapse. The number of employed totaled 23.24 million last month, down 12,000 from a year ago, marking the first annual reduction since October 2003. Two million Korean adults are technically unemployed.
``Economic recovery depends on how fast the labor and capital markets adjust to the stimulus. It is very important that new jobs are created and that they are taken by people who are losing their jobs in 'declining' sectors,'' Mauro F. Guillen, director of the Lauder Institute at the Wharton School of Business, told The Korea Times.
``A fully functioning labor market is especially important because if too many people lose their jobs without finding new ones, then consumption will go down and more loans will go bad,'' he added.
Faced with the one-two-three punch, the government has deployed all possible measures to minimize the impact.
The Bank of Korea (BOK) has slashed its base rate by a combined 2.75 percentage points to a record low of 2.5 percent since last October, while the government has vowed to offer tax cuts and provide financial aid for troubled banks.
However, market experts stress that the government should focus more on fiscal stimuli because other measures seem less effective. They say the root cause for the current economic turmoil is not a lack of liquidity but poor creditworthiness of potential borrowers.
``Lowering interest rates can't increase credit supply like before. Lenders wouldn't lend to bankrupt businesses, regardless how cheap the funds they get from central banks are,'' Xie said.
``A fiscal stimulus is the only thing that will be effective. Through creating demand directly or boosting income, economies will improve, and borrowers will become more creditworthy,'' he added.
Xie pointed out that debt reductions, either through inflation or bankruptcy, may be necessary to get the credit system back on track, noting that pumping money into financial institutions won't solve the problem.