Over the past several decades, real estate project financing (PF) has repeatedly triggered economic disturbances in Korea, with no fundamental remedies in sight until now. Project sponsors are at the heart of this issue, investing minimal equity while heavily relying on guarantees from third parties, such as construction firms, to push forward development projects entirely on debt. This financing structure is unheard of in major advanced countries. Korea needs to reform its unique PF structure by augmenting capital and reducing dependence on guarantees. - Over several decades, real estate project financing (PF) has repeatedly destabilized the Korean economy, but fundamental improvements have not been made. - The root cause of PF problems lies in the unique financing practice of relying almost entirely on debt, where developers invest very little equity and depend heavily on third-party guarantees. - In Korea, the equity ratio of developers is around 3%, while in major advanced countries, it exceeds 30%. - In major countries, land is secured with equity capital, and only construction costs are financed through loans. This approach prevents the issue of refinancing bridge loans into main PF loans, which is typical in Korea. - In major countries, it is rare for third parties, rather than developers, to guarantee PF loans, unlike in Korea. - The low-equity and highguarantee structure leads to more developers becoming smaller in scale and underfunded. - The low-equity and highguarantee structure leads to poorer assessments of project feasibility, no-questions-asked investments, and increased macroeconomic volatility. - The low-equity and highguarantee structure shifts all risks to the national economy, not developers. - Since advanced countries base loan issuance on project feasibility and financial structure per PF principles, capital augmentation is a prerequisite for developers to obtain loans. - However, when Korea introduced PF, the market consisted of small developers and large construction firms. This disparity led to a low-equity, high-guarantee structure, which was reinforced by the pre-sale system. - The prudent direction would be to raise the equity ratio to the level of advanced economies and abolish third-party guarantees. To that end, Korea should introduce regulations on capital augmentation. - While regulations to increase capital may constrain the quantity of housing supply, they are expected to improve its stability. - Even in environments unfavorable for scaling up, some developers have started small and grown into conglomerates, while others are affiliates of large corporations. - The pool of potential equity investors is not limited. - Because REITs socialize development profits and are already subject to equity ratio regulations, it is desirable to revitalize their equity investments or foster their direct participation as project sponsors. - During the transition, it is necessary to implement support policies that encourage capital increases. - The acute lack of data on real estate PF makes it difficult to even stay current, which in turn only allows temporary measures during crises and hinders regular monitoring or early crisis detection. - A database system should be set up to collect official statistics on financial and business information by project and company.

The preliminary feasibility study (PFS) was adopted in 1999 to enhance the objectiveness and transparency of government-run projects under the agenda of fiscal reform. It has received recognition from the World Bank, International Monetary Bank (IMF) and other prominent global organizations for its contribution to the efficient and transparent use of budgets. However, concerns have emerged about certain PFS-related issues attributed to the synchronization of PFS and budget allocation, and due to the growing public attention over PFS results. One notable issue pertains to the adequacy of estimations for land compensation, which accounts for a large share of the cost estimations for analyses on economic value. The competent authorities argue that the costs for land compensation―estimated through PFS―are unrealistically low and thus hinder project execution. The problem may lie within the PFS analysis itself, but it may also be because the gains from development are reflected in the real compensation costs. As such, this study focused on projects that were subject to PFS in 1999-2012 with available information on project dates and location. It analyzed the movements in land prices according to the project dates to examine whether government-run projects reflect the gains from land development in the compensation and if so, at which point they are reflected. The results were used to draw on the policy implications for land compensation estimations for future government projects. Time-series data was established on the prices of project sites or nearby land (per lot) for 14 government-funded projects from 1996 to 2014. Then, in a panel analysis using the difference-in-difference model, this study showed that the prices of both project sites and nearby land began to surge from a year prior to the initiation of PSF―during which time the competent authorities design a project and prepare for PFS―and continued throughout the PFS, basic design and implementation planning phases. Additionally, the prices of project sites exhibited a higher increase than that of nearby land until the basic design phase. The results indicate that the increase is driven by the fact that information on project design and development planning are made public and expectations are generated over the development gains as the project undergoes PFS. This, in turn, pushes up land prices and, although it can vary from project to project, the development gains during the basic design and implementation phase are reflected. The findings imply that PFS-estimated compensation costs are lower than real compensation costs not because of errors in the PFS estimations, but rather because of the time difference between cost estimation and real compensation, and reflection of the development gains during this period. Furthermore, a separate analysis of ongoing projects that passed PFS and those that did not revealed that the land prices for the project sites of the latter significantly increased far before the project was put forward but declined with the initiation of PFS, recording a lower growth than that of nearby land. However, once a project receives a budget and starts to roll, this pattern is reversed. Given that PFS and budget allocation have become increasingly synchronized, the market’s instant response to PFS results is a sign of a troubling reality. These findings indicate that to smoothly operate government-funded projects, it is necessary to foster prompt management of the entire process, from establishing the basic plan—including the release of information on project planning, compensation negotiations and project approval—to conducting PFS and developing the basic design. Above all, PFS should ideally take no more than 4-6 months. But, due to the lack of significant proposal contents such as location and the frequent changes in project plans, it can sometimes take 1-2 years before PFS results become available. To avoid this and conduct a prompt and timely study, the system should to be managed to allow only fully completed proposals to be selected as PFS-subject projects by the PFS committee. Also, once submitted, in principle, no changes to the project plan should be allowed. Compensation-related provisions in the PFS guidelines should also be revised to better reflect the current situation. The ratio of assessed values to market values of land has been quite low in Korea, and this is the partial reason behind the rapid hike in project site prices around the time of project establishment and growing gap between compensation costs as projects become delayed. Thus, PFS provisions regarding the land compensation ratio must be updated to reflect at minimum the actual conditions.

Analyzing Defined Contribution Pension Reform in Korea Using a General Equilibrium Model / SEUNG-RYONG SHIN Korea’s National Pension Fund (NPF) is projected to be in deficit by the 2040s and exhausted by the 2050s. Increasing contribution rates may be unaffordable, prompting consideration of structural reforms, particularly shifting from a defined benefit (DB) to a defined contribution (DC) system. The DC system links benefits to contributions and investment returns, ensuring financial stability but raising concerns about income adequacy and redistribution. This study uses an overlapping generations model with heterogeneous agents to assess these reforms. By 2070, demographic changes will make the DB system unsustainable without substantial government subsidies, adversely affecting taxes, income, and savings. Conversely, the DC system would remain balanced without subsidies, resulting in lower interest rates, higher wages, and better economic output. The model shows that the DB system would require an annual subsidy of 11.3% of GDP at a 9% contribution rate by 2070, while the DC system would be self-sufficient. Even with lower returns, the DC system could be more efficient and equitable with partial subsidies, improving economic outcomes and reducing inequality. Post-closure Career Paths of Self-Employed Workers / MINSUB KIM This study documents self-employed workers’ characteristics associated with their career paths after a business closure in order to improve employment insurance for such workers. Utilizing work history data from the Korean Labor & Income Panel Survey, a competing-risks regression model is adopted in order to study how self-employed workers’ career paths after unemployment (i.e., business closure) vary according to their characteristics. The findings suggest that the post-closure career paths of self-employed workers are associated with (i) their revenue and income, (ii) the individuals’ demographic characteristics, and (iii) the industry in which they operate. Several policy implications for employment insurance that better caters to the needs of self-employed workers are derived from the empirical results. Product Pioneers and Followers’ Choices on New vs Existing Plant to Product New Products: Evidence from Korean Manufacturing and Implications on Learning Spillovers / Chin Hee Hahn This paper examines whether product pioneers differ from product followers in their decision to establish a new plant to product a new product, utilizing a firm-plant-product dataset for Korean manufacturing from 1990 to 1996. We find that followers are more likely to establish a new plant rather than utilize existing plants to product a product which is new to the plant. We also find that establishing a new plant is accompanied by a larger investment than utilizing existing plants. These results seem consistent with the existence of pioneer-to-follower learning spillovers, possibly in the sense that followers face less uncertainty about the future profitability of the new product. The changing relationship between labor market conditions and inflation in Korea / Joonyoung Hur·Minsok Chae This paper examines the time-varying relationship between the labor market, inflation, and monetary policy, particularly in light of recent high inflation and a tight labor market, with a focus on data from Korea. Analyzing data from July 2009 to June 2023, we find that the impact of the job vacancy rate ― an indicator of labor market conditions ― on inflation has gradually increased over time. Furthermore, the responsiveness of inflation to changes in labor market conditions is found to be greater during periods of high inflation compared to low inflation. Lastly, the influence of monetary policy changes on the job vacancy rate is particularly pronounced during recessionary periods and after the COVID-19 pandemic. These findings suggest the possibility of convexity in the relationship between the labor market and inflation in Korea. In such a scenario, raising interest rates during high inflation could lead to a relatively larger decrease in inflation than in job vacancies, which could create a favorable situation for monetary policy management.

The Korea Development Institute (KDI), under the leadership of Director Cho Dong-chul, was honored with an appreciation plaque for its contributions to international knowledge cooperation based on Korea's economic development experience and policy cases, at the "Korea-World Bank Group Partnership Facility (KWPF) 10th Anniversary Conference" held on April 25th. *The World Bank KWPF is a trust fund established by the Korean government in collaboration with the World Bank in 2013. It is Korea's largest exclusive trust fund aimed at supporting sustainable economic growth in developing countries based on Korea's development experience and enhancing cooperation between Korea and the World Bank. KDI actively engages in various international cooperation projects such as knowledge sharing initiatives and capacity-building seminars to respond proactively to demands arising from domestic and international changes. It has successfully conducted numerous joint seminars and training sessions with the World Bank, sharing Korea's experiences in various fields such as the economy, infrastructure, and the environment. As an example, the recent project utilizing KWPF funds involved the "KDI GKEDC-WB Digital Tourism Capacity Enhancement Training," which took place from November 14th to 18th, 2022, providing knowledge transfer on Korea's tourism industry's digital transformation and operational expertise to Senegalese public officials. In light of receiving the appreciation plaque, KDI plans to continue its activities by consistently exploring recent policy cases related to international cooperation areas beyond Korea's economic development experience, such as climate crisis and digital issues, to meet development demands. Building upon these efforts, KDI looks forward to further strengthening its collaboration with the World Bank.

By CHANGWOO NAM,  Fellow at KDI ※ This article is part of KDI Journal of Economic Policy, November 2021 We analyze the social welfare effect when a policy-based financial system (PFS) enters a decentralized financial market. Particularly, the PFS in this case supports the interest spread for corporate loans held by firms with heterogeneous bankruptcy decisions under an imperfect information structure. Although support for capital costs through the PFS expands the economy consistently, the optimal level of PFS out of the corporate loan market is estimated to be 8.6% by a simulation model considering social welfare adjusted by the disutility of labor. This result is much lower than the recent level of PFS in the Korean financial sector. Why does the Korean government want to maintain a very large policy-based finance sector? In the 1960s and 70s, when the market was not well formed, the efficient allocation of limited resources was very important. Accordingly, the government would have a role in directly intervening in the market. The Korean financial industry underwent a major restructuring after the 1997 financial crisis and thus inefficient financial companies had been winnowed out and ousted such that the financial market, mainly composed of large banks, developed more readily, especially under the control of financial holding companies. However, large-scale policy-based institutions such as the Korea Development Bank, the Export-Import Bank of Korea and the Industrial Bank of Korea (hereafter KDB, KEXIM, and IBK) still play a large role in the Korean financial market. In particular, the guarantee insurance market, including the market for credit guarantees, has not yet been opened to third parties. In this situation, KDB and KEXIM have failed to promote the restructuring of insolvent companies properly. Recently, public opinion holds that the policy-based financial system should be greatly improved to achieve financial efficiency and for better financial market development. However, in order for public opinion to be reflected in the financial policy, it should be verified that the current size of policy-based finance in the Korean financial sector is excessive via rigorous economic logic. From this point of view, the subject of this paper is clear. In other words, this paper analyzes how social welfare arises and what the optimal size of policy-based finance should be in the financial sector when policy-based financial institutions that support firms by supporting loan interest enter the financial sector. In particular, this paper develops a general equilibrium model. First, firms are heterogeneous because they undergo idiosyncratic shocks individually. Second, commercial banks and policy-based banks (government-owned banks) do not fully observe these heterogeneous characteristics of firms. In other words, this paper basically assumes that the financial market operates as an imperfect information system when lending to firms. In this model, firms also decide whether or not to continue operating, that is, whether or not to default, depending on their heterogeneity.1 Finally, the analysis of social welfare does not aim to expand unconditionally the economy because the increase in the labor demand of firms by financial support is reflected in social welfare. To summarize the results of the analysis, the level of policy-based finance that optimizes social welfare through a simulation is found to be 8.6 percent of the financial sector. This figure is much lower than the 34.4 percent average in the Korean financial market over the past three years. Furthermore, noting not only that policybased finance is more likely to encounter moral hazard than private finance but also that policy-based finance is less efficient, it can be seen that the policy-based finance scheme implemented by the government in the Korean financial market is overabundant. This paper is organized as follows. Section 2 explains the current state of policybased finance in Korea, and Section 3 explains the theoretical background and how we designed the model in this paper. Section 4 explains the methodology and parameters needed for the simulation based on the theoretical model, and Section 5 explores the results of the social welfare analysis. Finally, Section 6 concludes the paper. ☞ <KDI Journal of Economic Policy, November 2021> (Click)  

  By Yoon Sang Moon, Fellow at KDI ※ This article is part of KDI Journal of Economic Policy, August 2020 This study aims to analyze urban population and employment growth among the indicators of regional development. Population dispersion is a direct goal of balanced regional development, but the distribution of a population cannot be changed rapidly in the short term. Therefore, I investigate how cities have grown over the long run by analyzing changes in population distribution and growth. I document that the population patterns of Korean cities follow well-known empirical laws, implying that the historical evidence supports random urban growth. Although the urban growth patterns appear to be random, I find that the historical data show a systematic urban growth pattern with the concept of market access, a geographical advantage. With this, I argue that employment in cities with high market access has increased more rapidly than that in cities with low market access, as population and employment have changed for economic as well as geographical reasons. Regional development policies in Korea have been implemented along with economic development policies. In order to advance, the industrial structure focused on light industry in the early stages of economic development, with heavy and chemical industries fostered in the southeastern region of the country. The government also provided various benefits to companies willing to move industrial infrastructure concentrated in the Seoul metropolitan area (SMA) to areas the outside of the SMA. These policies for regional development, dispersing industrial facilities and populations across the country, aim to lessen economic disparities across regions. The policy stance for resolving regional imbalances has become more prominent since the 2000s, and regional policies, such as the relocation of public organizations, have been implemented to achieve more balanced regional development. For balanced regional development, many reports have made comparisons between the SMA and non-SMA regions. Figure 1 shows the population trends in the SMA, referring specifically to Seoul, Incheon, and Gyeonggi-Do, against nonSMAs. The graph shows that the population of SMA continues to increase, currently accounting for more than 50% of the total population of Korea as of the end of 2019. However, there is little research on the agglomeration in regional development, which drives the growth of regions and so the disparities across regions. The agglomeration effects of concentrated urban areas arise not only in Seoul but also in other large cities. In regional hub cities other than Seoul, however, the agglomeration effects appear to be reaching its limit. Figure 2 shows the population trends of Korea’s metropolitan cities, in this case Seoul and six Gwangyeok-Si (metropolitan cities). All metropolitan cities except Incheon show decreases in terms of the population of registered residents. Busan experiences a population decline in all years except 1995 and 2010. In 1992, when data began to be collected, there were more than 3.8 million people in Busan, but in 2019, its population had declined to less than 3.5 million, showing nearly a 10% decline during that span. The population of Daegu, Korea’s third largest city in 1992, stagnated as it fell to the fourth largest city, behind Incheon, in 1999. Gwangju, the hub city of Jeollanam-Do, has been a smaller city than Daejeon since the late 1990s, showing a decline to less than 1.5 million. Daejeon had increased steadily, surpassing 1.5 million in 2010, but declined more recently, recording about 1.5 million inhabitants as of the end of 2019. Of the six metropolitan cities, Incheon alone sent positive news that it has recently exceeded 3 million. If the current trend remains, Incheon will become Korea’s second largest city in the next few decades. The decreasing trend in the populations of local hub cities has more important implications than a population comparison between the SMA and non-SMAs. Population is the main cause of the agglomeration effect of consumption and is closely related to employment, which is the main source of the production of agglomeration. It would be very beneficial for metropolitan areas to maximize the agglomeration effect by exchanging positive interactions within regions. The populations of local metropolitan cities are, however, decreasing, and they are less likely to show their potentials in aggregation. This means that preventing the decline of local hub cities could be one of the most important starting points for balanced regional development, which is one of the government’s main tasks. As shown in the following empirical analysis, if the populations of local hub cities continue to decrease, their agglomeration effects on the surrounding area will also lessen, which will in turn hamper regional development. It is necessary to promote the development of regional hub cities so as to disseminate the agglomeration effects to the surrounding areas. To that end, we will examine the distributions of populations across cities and how these distributions have changed over time. Population size distributions and growth are known to follow Zipf’s law and Gibrat’s law. With historical population data, I will confirm these empirical laws. In addition, the effect of the population distribution on the growth of cities will be investigated through an empirical analysis. Changes in population distributions due to population growth or migration will affect economic activities in urban areas, and this effect will depend on several geographical factors. Among these, the concept of ‘market access’ is introduced, quantified and reflected in the empirical model. Based on this model, data from Korean cities in five-year periods will be constructed as panel data and analyzed more rigorously through a fixed-effect model.  Market access is an advantage of economic geography, first introduced in the field of international trade. However, some factors related to international trade, such as tariffs, do not apply between regions within a country. Therefore, market access is more simply applied to the movement of people and goods within a country. As discussed in more detail later, market access is associated with the size of the local market and the distances across regions. In other words, if there is a large local market nearby, the region has high market access. Assuming that the regional market is proportional to the population, it can be said that the population distribution affects market access. When there is such a populous city or large market, the surrounding areas are likely to develop. The main purpose of this study is to estimate an accurate measure of the impacts of these large markets on their surrounding areas.  This study is organized as follows. In Chapter 2, I discuss in detail the population distribution and growth of cities in Korea. Chapter 3 introduces the concept of market access and presents a model of market access and employment growth to examine the relationship between them. Chapter 4 explains the data used with the model. Chapter 5 analyzes the effect of market access on urban growth and shows that the agglomeration effect of hub cities on the growth of neighboring regions is significant. Finally, Chapter 6 concludes the study.  ※ This paper is based on Moon, Yoon Sang, 2018, A Study on Agglomeration and Urban Growth: Market Access Approach to Urban Growth, Policy Study 2018-12, KDI (in Korean).