KDI - Korea Development Institute - RESEARCH - Research Areas

Summary

Policy Study KOR The Role of Invoicing Currency in International Trade: Determinants and Implications

This study examines the determinants of invoicing currency choice in South Korea’s international trade and analyzes how exchange rates affect trade outcomes across invoicing currencies. Using Korean product-level customs data, it documents distinctive patterns in Korea’s invoicing currency composition and identifies key factors shaping firm-level currency choices for exports.

These factors include the invoicing currency composition of imported intermediate goods, firm-level foreign-currency debt ratios, past invoicing practices, export market share, foreign exchange market size, invoicing currencies of competitors, and exchange rate volatility.

The results show that the degree of exchange rate pass-through varies significantly by invoicing currency, leading to meaningful differences in export volumes. Building on these findings, the study investigates the impact of recent exchange rate movements on Korea’s exports and demonstrates that the dominance of the U.S. dollar as invoicing currency imposes significant constraints on Korean export performance.

This study provides an updated and comprehensive overview of Korea’s invoicing currency patterns in trade, offering rich implications regarding the determinants and consequences of invoicing currency choice. The findings are expected to inform ongoing policy discussions on the revision of the Foreign Exchange Transactions Act, the internationalization of the Korean won, and broader initiatives aimed at advancing Korea’s foreign exchange market.

Summary

Policy Study KOR The Impact of Demographic Changes on Productivity

Demographic transitions in South Korea are projected to slow its potential economic growth through declining labor input and lowering total factor productivity (TFP). However, the TFP channel has been relatively underexplored compared to the labor input channel due to data limitations. To address this gap, this study constructs a comprehensive firm-level dataset by combining KISDATA from the NICE Information Service with income tax records from the National Tax Service. The resulting dataset includes information on both firm-level productivity and the age composition of employees, enabling a quantitative analysis of how workforce aging affects TFP.

The analysis reveals five key findings. (1) An inverse U-shaped relationship exists between employee age composition and TFP, peaking at ages 35-49. (2) Among employees aged 50 and older, TFP significantly decreases as their share rises. Relative to the 35-39 reference group, an increasing share of 40-49 year-olds has no statistically significant effect. However, a 1%p increase in the 50-54 share decreases TFP by 0.2%, and a 1%p rise in those aged 55 and above shows a larger 0.5% decline. (3) The negative impact of workforce aging is more pronounced in firms in the Seoul metropolitan area, firms with 50-299 employees, manufacturing and construction sectors, and firms operating over 30 years. (4) Firms with low average education and wage levels, high labor intensity, or low value-added per employee exhibit greater TFP declines due to workforce aging. (5) While strong seniority-based wage systems are associated with an earlier peak in the inverse U-curve, firms with weak seniority wages experience larger TFP declines due to aging.

The findings suggest that overlooking the TFP channel may lead to underestimating the demographic effects on economic growth. Mid-to-long-term population projections indicate that population aging will reduce TFP by an annual average of 0.2% between 2031 and 2041. The persistent downward pressure on productivity should be incorporated into assumptions about the future TFP trajectory.

This study identifies firms most vulnerable to population aging through heterogeneity analyses, offering targeted policy recommendations for South Korea's labor supply strategies. As industries become more labor-intensive, low-skill, and low-wage, their productivity declines are expected to be even steeper from workforce aging. Expanding younger foreign worker inflows in the short term can bolster labor supply, while long-term strategies should enhance productivity in these industries to attract domestic youth. Additionally, as seniority-based wage systems exacerbate the productivity impact of aging, reducing reliance on seniority and expanding task- and performance-based compensation systems is advisable for improving TFP.

Summary

KDI FOCUS The Impact of Demographic Change on Household Debt

Over the past two decades, Korea’s household debt-to-GDP ratio has trended upward, reflecting greater incentives for asset accumulation amid rising life expectancy. Household debt has increased through different asset accumulation patterns across generations: older cohorts prepare for longer post-retirement years by building financial assets that supply funds, whereas younger cohorts borrow them mainly to acquire housing. However, this trajectory is forecast to reverse in the coming years as longevity gains slow and accelerating population aging reshape intergenerational financial flows. Maintaining stability in the short to medium term will require close coordination between prudent financial policies and non-financial reforms, such as improving labor market flexibility.

- Korea’s household debtto-GDP ratio has risen steadily over the past two decades, pointing to structural rather than cyclical drivers.

- Declining interest rates amid sustained debt growth suggest that fund supply has outpaced demand.

- This study examines whether rising life expectancy can explain the sustained co-occurrence of increasing household debt and declining interest rates.

- The sustained rise in household debt over the last decade, despite income and wealth inequality remaining broadly unchanged, suggests structural drivers
beyond inequality.

- Household debt ratios tend to rise with longer remaining life expectancy and decline with higher old-age dependency ratios, suggesting demographic shifts as a major driver in shaping debt dynamics.

- Life expectancy has risen rapidly, but with the retirement age unchanged, the postretirement phase has lengthened, strengthening incentives for asset accumulation.

- Middle-aged and older cohorts primarily invest in financial assets and supply funds, while younger cohorts build housing assets by borrowing from them,
accumulating debt.

- In the past decade, per capita debt has increased among younger cohorts and decreased for older cohorts.

- Changes in age profile have influenced household debt dynamics.

- A declining share of younger cohorts borrowing for housing, combined with a rising share of older cohorts drawing down assets for consumption, may lower the household debt-to-GDP ratio.

- A one-year increase in life expectancy raises the household debtto-GDP ratio by about 4.6%p, while a 1%p shift in population share from the younger (2544) to the elderly (65+) cohorts reduces it by roughly 1.8%p.

- The empirical analysis indicates that rising life expectancy explains most of the increase in Korea’s household debt-to-GDP ratio over the past two
decades.

- The household debt ratio is projected to peak in a few years before entering a downward trend.

- Stronger incentives for asset accumulation from rising life expectancy, together with portfolio differences across age groups, have been the primary drivers of household debt growth.

- With slowing gains in life expectancy amid accelerating population aging, the household debt ratio is likely to enter a downward trend.

- Flexible, performance-based wages can strengthen labor market efficiency and ease household debt pressures.

- Household debt policy should prioritize repayment capacity and soundness of financial institutions over arbitrary aggregate targets.

- Scaling back DSR exemptions will be critical.

- Excessive policy financing may lead to household debt growth, underscoring the need to recalibrate guarantee ratios and fees and examine the overall policy financing system.

Summary

Research Monograph KOR Macroeconomic Challenges and Policy Direction for the Post-COVID Era

Korea experienced changes in its economic architecture in the aftermath of two major economic recessions, the Asian Financial Crisis and the Global Financial Crisis. However, triggered by a non-economic factor of infectious disease rather than structural problems of internal and external economies, the COVID-19 crisis unfolded differently from the two previous downturns after 2020. In response, the Korean government carried out aggressive fiscal, monetary, and financial policy measures, together with the early signing of a currency swap agreement with the US. Its quick and decisive actions helped stem capital flight and swiftly stabilized the financial market. Another unique feature of the current crisis is its hugely uneven shocks among economic entities. Notably, the face-to-face service industry had a significant contraction due to its high susceptibility to contracting the virus. Still, asset prices soared even in the pandemic-induced recession thanks to abundant liquidity supplied into the market, widening the gaps in labor and asset income.

Based on the observations, this study intends to analyze the macroeconomic aspects of the ongoing situation and take lessons from it. While investigating the crisis itself, it also attempts to make projections of possible changes in the post-pandemic world and offer policy implications. It first analyzes the pandemic recession on the basis of an economic cycle and identifies what sets this incidence apart from past economic downturns. Then, it turns to the labor market to analyze the impact on jobs and forecast possible structural changes while further examining the features of firms that fared relatively well. Lastly, fiscal and monetary policy measures during the crisis are evaluated to provide implications for the future macroeconomic policy direction.

Summary

Policy Study KOR Fiscal Policy in Open Economies: Capital Accounts and the Crowding Out

We analyze the effect of fiscal policy of open economies, and examine the effect of fiscal policy on domestic corporate investment. Capital flows are important factors in determining the effect of fiscal policies in a small open economy. Fiscal expansion which tries to boost overall demand could, in principle, be restricted by various factors. So-called crowding-out could reduce the effectiveness of fiscal expansions, and thus lower the fiscal multiplier. Capital flows could play an important role in determining the effects as it determines how the revenues for fiscal expansion are financed. Here, we examine the magnitude of the fiscal multipliers with different states of capital flows. Through the structural vector auto regression (SVAR) model using the sign restriction on national panel data from 42 countries, we find that fiscal multiplier is higher when capital inflows and lower when it outflows. And the responsiveness of different states of capital flows are more notable in investment than in consumption, the other component of GDP accounts.

In the second part of the paper, we further examine the corporate investment of Korea. If the crowding-out prevails, fiscal expansions could lower the overall investment. Increased supply of government bonds will substitute corporate bonds in the loanable funds market. However, if it could partially be off-set if firms could fund their investment from international investors. That is, if individual firms could finance their investment from external funds, it could unwind the crowding-out of the fiscal expansions. We analyze Korean firm level data from 2005 to 2020, and confirm that with fiscal expansions, investment ratio decreased especially in companies with high debt-to-equity ratio. However, those negative correlation is not observed in a sample of companies which hold foreign debts or have foreign main banks.

Summary

Policy Study KOR Investment and Business Cycles: focusing on Investment Dispersion

This study empirically verifies that the form of the adjustment cost function serves as an important mechanism in investment decision-making after confirming that the investment dispersion of Korean companies is pro-cyclical and can affect economic fluctuations. Specifically, it is revealed through empirical analysis using corporate financial data rather than a macroeconomic model that the investment adjustment cost function generally assumed in macroeconomics is asymmetric and irreversible in the Korean economy. In particular, since the substitution effect of the marginal value-to-cost of a one-unit investment in inter-temporal investment decision-making is affected by the additional adjustment cost from the sale of equipment assets, and not the investment in equipment assets, it is empirically proven to lead to an expansion of investment dispersion. This ultimately shows, albeit indirectly, that investment dispersion can affect economic fluctuations as the investment adjustment cost function influences the decision-making in investment. What is implied here is that the adjustment cost function is not merely a deep parameter that fits the dynamics of economic fluctuations in a macroeconomic model, but it could be a macro policy variable that can be endogenized through economic policy.

Summary

KDI Policy Forum KOR Examining the Liquidity Risk in the Household Sector and the Policy Implications

■ In the wake of an unprecedented health crisis, households who lack liquid assets that could tackle their growing deficit (=income-expenditure) will endure severe financial difficulties.

■ The share of households facing liquidity risk will increase as incomes fall by bigger margins and exposure to the shock intensifies.

■ The liquidity risk resulting from COVID-19 will be even more pronounced among the economically vulnerable; specifically, those in the bottom quintile in terms of income and net assets, and temporary and daily wage workers.

■ Households at liquidity risk are particularly concentrated in the low income quintile. As such, a short-term income support program offering even a small amount of aid (e.g. 1 million won) could greatly help to reduce their liquidity risk.

■ In terms of support for at-liquidity-risk households, a selective approach which focuses the income support on the economically vulnerable and provides credit support in the form of collateral loans to asset-owning households will be more effective in easing the liquidity risk and the government’s fiscal burden.

Summary

Policy Study KOR The Effects of US Monetary Policy on Gross Capital Flows: Cases in Korea

There are claims that US monetary policies generate global spillovers and destabilize small open economies. Accordingly, the effects of identified US monetary shocks on Korea’s gross capital flows were analyzed using the local projection method. Consistent with previous results on other small open economies, we confirm that US rate hikes are dynamically correlated with foreign outflows and resident inflows. That is, not only is there a correlation with the withdrawal of foreigners, but also with those of domestic (Korean) investors; primarily driven by portfolio flows. However, the marginal response to the shocks has been subdued in the sample periods following the Global Financial Crisis. A possible reason behind the change may be the institutional shift in regards to financial friction. If the degree of pledgeability on the value of net worth increases, the marginal response of investors will drop on a US monetary shock which is in line with our findings.

Summary

Research Monograph KOR Openness and Economic Development

We identify whether open economic policy has played a key role in facilitating economic development in Korea, and if so, through what mechanism the openness has induced Korean economic performance by applying modern economic theories and empirical analyses. Many studies that deal with the relationship between openness and Korean economic development tend to assess it from the perspective of economic history, lacking systematic approaches in explaining causal relationship based on theoretical and empirical analyses. Thus, this collection of individual study, incorporating forceful theories and empirical evidence into research, supplements the existing literature and open a gate for further researches. We also discuss the policy implications of the findings at the end of each chapter.

Summary

KDI FOCUS Korea's Participation in Global Value Chains and Policy Implications

□ The expansion of global value chains during the past 20 years has widened the gap between export value and domestic value added, diminishing the per-unit contribution of exports to the country’s economic growth. Thus, policies now need to target creating value added rather than increasing gross exports and focus on enhancing the competitiveness of input and production activities. In particular, regulatory reform must take place in the service sector to eliminate unnecessary obstacles to competitiveness. Moreover, to utilize global value chains more effectively, efforts should be made to enhance the efficiency of offshoring and attract production to the country’s shores in order to create more domestic valued added and jobs.

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