By Matt Robinson
Economist, Moody's Economy.com
We have been witness to considerable improvements in the Korean economy since the Asian financial crisis of 1997-98. Corporate governance has been enhanced, the financial system is stronger, the current account has moved into surplus and the national currency has recovered to near pre-1997 levels. But one area where the lasting effects of the crisis have persisted is in investment levels.
Investment over the Past Decade
In the aftermath of the financial crisis of the late nineties, there was a marked step-change in investment in Korea - as there was in other crisis affected countries. Gross fixed capital formation in the Republic constituted almost 40 percent of GDP pre-1997; it averaged closer to 30 percent of GDP in the years following the crisis.
Arguably some of the downturn in investment can be attributed to the effect of the pre-crisis excesses. The perceived riskier investment environment and weaknesses in the financial and corporate sectors have deterred foreign investment; a pre-condition of some of the IMF loans involved limitations on public spending; and private sector reluctance to invest in all but the export sector limited the expansion of the non-tradable domestic sector.
A more worrying trend, however, has been the further erosion in capital spending over the past few years. Since 2004, fixed capital investment has gradually declined further, dipping as low as 28 percent of GDP in the first half of 2006.
High levels of capital expenditure were an integral ingredient to Korea's recipe for growth during its boom years in the seventies and eighties. Strong investment means that the quantity and quality of capital equipment that workers have at their disposal is improving. The boost capital investment gives to the nation's productivity is the equivalent of giving a farmer a tractor and dispensing with the horse-drawn plough.
The economy's stock of equipment and machinery, infrastructure, education system and the quality of the country's institutions are fundamental to economic development. Low levels of investment in physical, human and social capital leads to poorer productivity growth, lower wage growth and smaller improvements in living standards. Encouraging productive investment is therefore an essential element in generating and improving economic growth prospects.
Over the past couple of quarters, the trend decline in investment in Korea appears to have finally turned the corner. Since its low during the second quarter of 2006, growth in capital investment as a proportion of GDP has finally turned positive. Given its importance then, policies aimed at sustaining the recent improvement in investment should be a key focus of the Korean administration.