By Ronald Man
It’s a tough time to be a policymaker in Seoul and life may be about to get more difficult for consumers too. Since the European debt crisis, sluggish growth in Korea is now being accepted as the norm. We expect the Korean economy to expand 2.6 percent in 2012, down from 3.6 percent last year and the outlook for 2013 is also weak. The Bank of Korea, too, will probably cut its forecasts for the third time this year in October. Our concern is that if the economy remains weak for an extended period, three deep structural problems may develop.
First, household debt will continue to rise and become riskier. A slowdown in the giant manufacturing sector will hit the pay packets of poorer households hard, forcing some consumers to pile up credit card debt as they struggle to maintain their standard of living. This, in turn, increases the likelihood that banks will face a higher percentage of non-performing loans.
Then there’s rising inflation, which accelerates the build-up of household debt. We expect the consumer price index to creep up on the back of higher food and commodity prices in the last few months of the year after touching a 12-year low. Korea is highly dependent on food imports, making shoppers vulnerable to unpleasant surprises in other parts of the world, such as the recent droughts in the U.S. For example, the price of soybeans has risen 40 percent this year.
Second, the productivity of the country's labor force may fall. A sluggish economy means that fewer jobs are created. Over time, unemployment would diminish the competitiveness and productivity of the Korean workforce. Younger workers tend to be particularly vulnerable to economic downturns. In 2009 employment among workers aged below 30 fell 3 percent year-on-year, while jobs for those over 30 held steady.
Demographics are important here. The country’s workforce will start to shrink from 2016 according to the United Nations, so the productivity of each young worker today must increase to compensate for fewer workers in the future. This puts pressure on policymakers to create jobs for young people.
Third, businesses may increasingly cut back on investment. For example, construction has been declining this year. In part, this reflects weaker housing prices that have been falling since June, with demand suppressed by the self-fulfilling prophecy that prices will remain weak. Korean property is now at its most affordable level in over 20 years, but there is still a large stock of unsold housing across the nation.
Manufacturing is another area of concern. Investment has suffered its sharpest contraction since March 2009, largely because demand is slowing and inventory levels remain high. Should manufacturers continue to push back investment, there is a danger that this will reduce Korea's ability to meet demand once the global economy picks up.
So, what should anxious policymakers do? For a start, the central bank can cushion the deceleration in growth. The use of conventional monetary and unconventional methods (e.g. quantitative easing) used by Western central banks have arguably helped their economies to avoid a Great Depression-style meltdown. However, given the strong decline in domestic and external demand, monetary policy alone may prove insufficient to generate a sustainable recovery in Korea. Luckily, the government has the fiscal firepower to lift growth by lowering taxes and increasing public spending. The priority, however, should remain on increasing job creation because it is one of the most efficient ways to kick-start sustainable domestic demand when conditions overseas remain fragile.