The Korean economy exhibited improvements in growth with a rapid increase in production led by the manufacturing industry.
3Q 2017 GDP recorded 3.8% YoY, up from a quarter ago (2.7%) and QoQ growth rebounded to 1.5% (6.3% on an annualized basis).
Consumption showed a comparatively gradual increase but the trend in domestic demand was favorable on a high growth in investment.
Exports surged led by IT-related industrial sectors including that for semiconductors, driving the improvements in the growth rate.
A semiconductor-centered structure for export growth points to a heavy dependence on the conditions of the global semiconductor market for the ongoing economic recovery.
The production growth in manufacturing, which has driven the recent GDP growth, appears to be concentrated on the production of semiconductors. Of domestic demand indicators, facilities investment exhibited the most robust upward trend but it is becoming increasingly dependent on the expansion of manufacturing equipment by semiconductor companies.
Overall employment exhibited no meaningful progress as economic improvements were skewed towards the semiconductor-driven manufacturing sector.
Employment in manufacturing grew marginally from 2017. But, total growth stagnated due to the contraction in services employment while the unemployment rate stood in the high 3% range.
Meanwhile, with an increase in the global trade volume, expectations are growing over a recovery of the global economy.
The recent global recovery, led by advanced economies including the US, will be driven by the rise of the ICT industry in the mid-term.
Based on the projected recovery of the global economy, the Korean economy is also expected to continue to improve for some time. However, this implies that Korea’s sustainable growth may not be easily achieved.
The Korean economy is expected to sustain the current structure, which is dependent on certain industries. Under such circumstances, even a short-term improvement of the economy will inevitably be vulnerable to shocks from deteriorating terms of trade, such as falling semiconductor prices and rising oil prices, and to uncertainties arising from policy and geopolitical factors in major countries.
Accordingly, macroeconomic policies should be managed through the current accommodative stance for the time being while providing support to achieve a balanced growth across industry.
Despite recent improvements in economic activities, employment has not been stimulated much, implying that it is not the time to shift policy towards a tightening stance.
Meanwhile, the imbalance in the current economic improvements should be understood in relation to the structural problems in the Korean economy. So, a policy mix should be explored and actively implemented for a harmonious balance and efficiency.
In this context, the government’s policy mix, which aims at job creation, reduction of income inequality through fair distribution and promotion of innovation-based progress in productivity, could make meaningful contributions to solving the economy’s structural problems.
To ensure a better chance of achieving sustainable growth through stronger economic competitiveness and productivity, policies on corporate and industrial restructuring and the structural reform of economic systems should be constantly pursued from a longer-term perspective.
An environment must be created in which resources are seamlessly reallocated to enhance productivity, and this could be made possible by removing the structural inefficiencies of the economy, including lagging industries and firms, through restructuring.
Structural reform should aim to enhance economic flexibility and attain fairness so that the focus can be placed on strengthening growth potential through efficient resource management, and on establishing an economic structure that guarantees balanced growth and fair distribution.
Ⅱ. Domestic Economic Outlook for 2018
1. Major Expectations for the External Environment
The global economy will continue to grow in 2018 at a similar rate to 2017.
The IMF projected that major advanced economies, except the US, will experience a slight decline in growth. However, global economic growth will record 3.7% in 2018, similar to 2017 (3.6%), as emerging economies improve.
Crude oil prices will rise by 5% from 2017 to around $55 per barrel in 2018.
In 2018, the value of the Korean won, in terms of the real effective exchange rate, will appreciate by approx. 1%.
2. Outlook for Domestic Economy
The Korean economy is forecast to grow at a 2.9% range in 2018 as export growth continues, consumption improves but investment slows.
Exports will maintain a modest growth owing to the stable growth of the global economy. Moreover, domestic demand will decelerate slightly due to falling investment while consumption improves.
Growth in private consumption will accelerate in 2018 influenced by policies for income-driven growth and job creation, although interest costs will rise on a rate increase.
Facilities investment will shrink relatively fast as the capacity utilization rate remains low in most sectors, except semiconductors. However, investment demand will rise on expanding exports.
Construction investment will experience a relatively large loss in growth as the civil engineering sector continues to slump and the building construction sector, especially housing construction, slows.
Exports will continue the relatively steady growth as the export of key items such as semiconductors improves moderately amid a continued growth in the global economy and trade volume.
The current account is projected to run a similar surplus to 2017 as net exports expand while the terms of trade deteriorate on a slow growth in export prices.
The CPI is expected to stand at a mid-1% as private consumption improves relatively fast while the temporary effect of oil price hike disappears.
Employment growth is projected to decrease slightly from 2017 as private consumption improves but investment slow relatively fast. The unemployment rate is likely to remain similar to 2017.
On the external side, falling unit prices of major export items and weakening global competitiveness will become downside risks to growth projections. But, accelerating growth in the global trade volume and the US’ tax cut policy will serve as the upside risks.
If semiconductor prices plunge or flagship export items lose their competitive edge due to China’s catch-up, the Korean economy, which is heavily dependent on foreign trade, will likely grow at a slower pace than expected due to deteriorating terms of trade and shrinking product shares in the export market.
If global trade volume expands faster than expected or export demand rises on a US tax cut, these could pose upward risks to the growth projection.
On the internal side, soaring market interest rates and falling asset prices could pose downside risks and increased consumption driven by government policies will be an upside risk.
A surge in asset prices amid a spike in market interest rates will increase volatility in the financial market and sharply weaken repayment ability, which could lead to a sudden setback in economic growth.
Meanwhile, the Korean economy will exhibit higher-than-expected growth if government policies to raise household income are implemented in earnest and consumer sentiment steadily improves and private consumption rises rapidly.
Ⅲ. Policy Recommendations
1. Fiscal Policy
The 2018 budget bill adopted fiscal factors necessary for the new administration in its quest to fulfill policy agendas. The stance of the fiscal policy is deemed to slightly accommodative at a level that will sustain fiscal soundness.
Based on the favorable revenue conditions, total expenditure is raised only to a level that will not undermine fiscal soundness while supporting the attainment of national goals through an adjustment of sectoral financial resources.
As the tax-to-GDP ratio rises due to fiscal expenditure increasing and the role of social insurance expanding, the distribution of financial resources needs to become more efficient through a restructuring of tax expenditure and improvements in the substantial management of social insurance.
The direction and priority of mid- to long-term fiscal expenditure should be specified through a strategic review while efforts for expenditure restructuring should be strengthened so that funds would be focused on highly effective public projects.
Meanwhile, it is desirable to expand the role of social insurance in order to strengthen social safety nets, but the resulting higher insurance premiums and broader financial support will place a heavier burden on the public. Therefore, social insurances need to be managed in a more efficient manner in order to monitor their financial conditions and control sudden spikes in spending.
Based on the improvements in tax revenue conditions, the government should explore avenues into securing financial soundness while taking a more proactive role in fiscal affairs.
2. Monetary Policy
Monetary policies should maintain an accommodative stance for the time being in consideration of the current inflation and economic situations.
With CPI inflation falling after reaching the target in 3Q, it is premature to conclude that the recent improvements in economic activities are strong and steady.
Meanwhile, it is desirable to create an environment in which monetary policy decisions are made based on macroeconomic situations while letting the impacts from external factors such as additional US rate hikes being absorbed by the changes in prices such as FX rates in the financial market.
Additional policy revisions should come with sufficient explanations about the needs and grounds based on an analysis of the repercussions across the overall economy to enable more accurate projections by economic agents and to minimize the possible side effects.
3. Financial Policy
Financial policies should work to accumulate enough loss-absorbing capacity to prepare for a possible crisis and induce capital flows into more productive sectors. Also, the effectiveness of announced policies on household debt should be ensured.
As interest rates are increasingly likely to rise, the vulnerable borrowers are more exposed to the threat of default risk. In this regard, the policy should inspect the effectiveness of the existing policies and specify broad policy directions into more concrete action plans so that uncertainties would be minimized.
In addition, the policy should enhance the ability to prepare for a possible crisis beforehand through a counter-cyclical capital buffer and also induce the funds concentrated on household sectors to be distributed to more productive sectors.
To stimulate financial innovation, the current legal and regulatory systems on finance need to be revised and switched from rule-based to principle-based.
4. Labor Market Policy
In response to changing economic and social conditions due to the rapid technological progress, concrete measures should be developed to secure stability and flexibility in labor demand in the mid- to long-term.
In addition, a training system should be developed in order to keep pace with the changes in labor demand.
Excessive regulations on quota and tuition fees in the higher education system need to be alleviated so that university education can respond to labor market demand in a more flexible manner.
Also, the vocational training system needs to be upgraded and extended to more people regardless of age and educational background so that they can obtain the necessary skills.
5. Regulatory Policy
To increase the possibility of innovation and to promote innovation-based growth, it is essential to create an innovation-friendly regulatory environment and revise anti-competitive regulations on market entry and operations.
The regulatory environment can be transformed to become more innovation friendly through improvements in the regulatory administration process and redesign of regulations.
Meanwhile, to improve market entry and operation regulations that restrict competition, efforts are needed to formulate effective action plans and strategies that can subdue the resistance of existing businesses while creating a positive public consensus for improvement.