Boosting consumption key for economic turnaround

Consumers look at clothes at I’Park Mall at Yongsan Station, Seoul, Thursday. Department stores are launching promotional events to attract consumers who are refraining from spending amid stalled income growth and the insecure job market. / Yonhap

By Yoon Ja-young

When Kim heard the news that the country’s per capita income is nearing $30,000, he wondered why he doesn’t feel that rich. The 48-year-old, who works as a manager for a mid-tier manufacturing company, owns an apartment in Seoul, valued at around 550 million won, and earns 60 million won a year. However, he said he is always worried about money.

“After paying my mortgage and tuition for my kids, there is no money left for saving. When I think about my life after retirement, which will come after a few years, there seems to be no solution at all. I am just trying not to spend money on unnecessary things,” he said.

Koreans are cutting consumption, but the natural decision is raising the fear that this may pull the economy into the long recession that Japan has been struggling with.

According to the Bank of Korea, real private consumption increased 1.8 percent last year, marking the lowest growth since 2009. It has remained under 2 percent for three consecutive years.

Hyundai Research Institute research fellow Lim Hee-jung said the economic slump that is continuing longer than expected is making households feel insecure about the future, and therefore they are cutting spending.

“People aren’t seeing the signs of economic recovery. Moreover, the real estate market has been falling from the peak, leading to a negative wealth effect. Household debt is also hindering consumption,” he said.

Lee Geun-tae, an economist at LG Economic Research Institute, agrees that the sluggish housing market has led to a consumption cut. In Korea, it comes as a more serious threat as it is coupled with the aging of society.

“While real estate comprises most of the assets for elderly households, housing prices have stopped soaring. They are now lacking assets for life after retirement. They are thus preparing for the future instead of consuming,” Lee said.

Korea is going through an unprecedentedly rapid aging of the society, with experts expecting it to become an “aged society” in 2018. This refers to a society where senior citizens aged 65 or older comprise more than 14 percent of the population.

Lee pointed out that this means sluggish consumption is a structural phenomenon in Korea ― people are cutting consumption over concerns on life after retirement.

“With the growth potential falling, people have little expectation on their future income as life expectancy has increased,” he said.

Soaring jeonse prices are also hampering consumption, according to Park Jong-kyu, a senior research fellow at Korea Institute of Finance. Jeonse is Korea’s unique property rental system where tenants pay a lump sum deposit to a landlord at the start of a rental contract. The tenant gets the full deposit back at the end of the contract. According to Real Estate 114, a real estate market information provider, jeonse prices of apartments in Seoul rose by an average 21.9 percent during the past two years. While tenants have little money to spend after providing such a huge deposit, landlords put the money into bank savings instead of spending it. Neither of them will be contributing to consumption. “The money just goes to the bank,” he said.

Long-term solution needed

As there are fundamental problems behind the sluggish consumption, experts say it won’t be easy to boost it. However, they agree that the government should focus on long-term perspectives.

Lee at the LG Economic Research Institute called for reform of the public pension.

“It is rational for consumers to cut spending to prepare for retirement. They distrust the public pension.”

He advised the government to first reform the public pension to make it sustainable. The government estimates the public pension fund to deplete by 2060 without reform.

Lee stressed that the public pension should provide more protection for life after retirement.

He also advised that the government should nurture new industries to create consumption.

“In the past, there was considerable demand for sectors like education or telecommunications. However, people are cutting consumption in these sectors as well,” he said. While Korea is still known for its extreme education fervor, parents don’t seem to think education offers as much of an investment return as before, he said, citing falling ratio of students advancing to college. Diminishing interest in the latest smartphones has also made consumption in telecommunications sluggish.

He said the government should nurture new sectors to substitute for them and lead consumption, while encouraging high income earners to spend more.

Park Jong-kyu, a senior research fellow at the Korea Institute of Finance, meanwhile, advised the government to tackle the issue from the income side _ people aren’t consuming because they have no money to spend.

“We are seeing low savings rate, increasing debt and sluggish consumption at the same time. Only sluggish income can explain all three of these phenomena,” he said.

He pointed out that the economy has been experiencing “wageless growth” since 2008.

“Since the previous administration, there has been gap between real wage and real labor productivity. While productivity has risen, wages have remained stagnant. Korea has the biggest gap between the two among 25 countries with comparable data. I am not saying that wages should be raised recklessly, but they should be commensurate to productivity,” he said.

“From the Keynesian perspective, total demand may decrease if businesses try too much to save on wages. Korea has reached this point,” he said.

Park added that while the central bank has lowered its key rate to a historically low level, it is like double edged sword.

“Korea entered the era of low interest around 2001, when the whole world was cutting rates after 9.11. As a result, private consumption picked up for 2001 and 2002. However, as the government continued lowering the rate, households came to have little interest income to spend. Around 2004 and 2005, the negative impact from falling interest income offset its positive impact on consumption.”

Lim at the Hyundai Research Institute stresses that all policies have both positive and negative sides. “If you focus on revitalizing the real estate market to boost consumption, for instance, it increases household debt, which works negatively on consumption.”

He said the government should look at the whole picture from a long term perspective, stressing that choosing long term solutions means accepting short term side effects.

Among the diverse causes of the sluggish consumption, he suggests tackling household debt first. This may include forgiving part of the debt while minimizing moral hazards.

“When economic players come to think better of their future, they will start consuming. The economy will pick up,” he said.