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Management Report

Management reports, briefs and video-clips issued by Samsung Economic Research Institute

How Can the Korean Economy Fly High?

How Can the Korean Economy Fly High?

JEON Young-Jae

Feb. 19, 2008

Transcript

Welcome to our Video Program. I’m Young-Jae Jeon from the Macroeconomics Department. Today, we’ll take an in-depth look at how Korea can achieve high economic growth despite ever-worsening external conditions.

The countdown has begun to the inauguration of the new administration which will take office on February 25. During his election campaign, President-elect Lee Myung-Bak pledged to achieve 7% economic growth. The new administration, however, revised the 2008 economic growth target downward amid rising concerns over the US economic slowdown. Despite the downward adjustment, the new administration still has much ground to cover to achieve its target.

Let’s take a glimpse at which external and internal conditions the new administration is facing now compared with those of the Kim Dae-Jung administration and the Roh Moo- Hyun administration.

The Kim Dae-Jung administration was launched in 1998 when the nation’s foreign reserves were exhausted. The ROH government was inaugurated in 2003 when the world economy was entering a boom and domestic conditions were under strain from collapse of the credit card bubble.

Compared with its predecessors, the new administration is starting under relatively favorable conditions. In terms of external economic conditions, the Kim Dae Jung administration was inaugurated at the bottom, and the Roh Moo-Hyun government at the top. The new administration stands halfway between them. As for domestic conditions, the Kim and Roh administrations both went through a drastic economic slowdown in their first year, while the new administration is enjoying a free ride on the economy that is making a steady recovery.

The biggest stumbling block facing the new administration is a slowdown in the world economy. To make the Korean economy fly high, the new administration needs to break through the current low-growth trap. To this end, it needs to develop a new growth paradigm in order to offset any slowdown in exports.

Korea has had real economic growth of about 4% since the 1997 financial crisis, while its potential economic growth rate was around 5%. Private consumption also was below the optimum level. It has yet to regain the pre-1997 boom levels. It was also hit hard by the collapse of the credit card bubble in 2003 and thereafter, has remained subdued. In addition, corporate investments have been sluggish since 1997 due to risk-averse management and excessive regulations.

The new administration could achieve its targeted 6% growth if it succeeds in reinvigorating consumption and investment alike.

Based on the assumption that the ratio of current account deficit to GDP needs to be below 3% for economic growth, 6% economic growth requires a 5.6% growth in private consumption and a 6.5% in fixed investment. This level of growth is not too high to be achieved.

Expansion of domestic consumption is needed to make the Korean economy leapfrog again. To expand the consumption base at home, investment and consumption need to be stimulated. The new administration could energize the investment climate by lowering corporate taxes and minimizing regulations. Private consumption could be bolstered by alleviating the public’s burdens and stabilizing the asset market.

Let’s take a closer look at the four ways of boosting investment and consumption. First, it’s necessary to cut the maximum corporate tax rate to 21% from the current 25%. It could result in a decrease of 2 trillion won in the government’s total corporate tax revenue, an amount equivalent to 7% of the government’s 2005 corporate tax revenue. This measure, however, could translate into an increase of facility investments by 3.1 percentage points per annum over the next five years. Plus, the new administration also needs to expand the current R&D investment tax credit law, while providing more incentives to encourage the development of new technologies.

Second, the new administration needs to take steps for across-the-board deregulation. It’s estimated that if Korea reduces its regulations to the level of industrialized countries, it may increase the nation’s facility investment by up to 4.8 percentage points. It’s increasingly necessary to greatly relax the regulations on large businesses in metropolitan areas.

Third, reform of the social welfare system is needed, including the national pension system, to relieve burdens on the public. The public educational system also needs to be improved by introducing the principle of autonomy, aimed at lessening the burden of private educational expenditure.

Fourth, the high volatility of the asset market acts as a stumbling block to stable growth in consumption. Therefore, it’s necessary for the new administration to regard asset prices as a core variable, like consumer prices, that needs to be paid careful consideration in the operation of monetary policies.

In sum, the world economy is now entering a slowdown phase and is likely to experience a long adjustment on its way. It’s time for Korea to change from an export- oriented growth model towards domestic demand-based growth. This is the key task facing the Korean economy to achieve high sustainable growth. Thank you for watching. I’m Young-Jae Jeon.

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