Rebalancing is the key

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Rebalancing is the key

The new year has started off with upbeat economic prospects. It may not be all sunshine, but the dark clouds over the global economy are finally beginning to thin. The economies of the United States, Japan and Europe are all becoming stronger, and China, too, is expected to perform better than last year.

South Korea also is in a recovery phase. The government estimates 3.9 percent year-on-year growth in 2014 and the Bank of Korea forecasts 3.8 percent. In her New Year’s address, President Park Geun-hye promised to stimulate recovery and boost the country’s growth potential through a three-year innovation plan.

There is much work to be done in order to keep the Korean economy moving beyond the cyclical recovery. The president cited new drivers for growth - normalizing the abnormalities, building a creative economy and vitalizing domestic demand. From a more macroeconomic perspective, the government must add re-balancing lapses and discrepancies across the economic sector to the plan for sustainable growth.

On the external front, the turnaround phase in the global economy will likely last three to four years. The United States would incrementally wind down the mega-scale quantitative easing to help liquidity flow since the financial meltdown in 2008 and may start tightening - or increasing interest rates - from early next year.

Market rates already are moving on such expectations. Japan will likely continue aggressive monetary easing until the economy is decisively out of its deflationary cycle and the yen is safely devalued.

Over the next three years, overseas demand will generally grow, international borrowing rates will go up and the Korean won will remain strong against the yen. Korean economic performance will depend on how well the economy adapts to changes in the external environment.

Since the financial meltdown, the United States and European countries have pursed deleveraging by encouraging the private sector to reduce debt levels. The economic slowdown was prolonged because companies and households had less to spend while paying off their debt. Debt levels have decreased after years of restructuring and spending is slowly picking up.

The Korean economy is going in the opposite direction. The household debt-to-income ratio hovers at the world’s highest levels, dampening consumption, and more and more public companies have trouble paying even the interest on their debt with operating profit. If interest rates move higher, household debt could explode. It is essential to decrease household and public-sector debt levels for stable economic growth. Restructuring requires austerity that would depress domestic demand. The strong won could also hurt export competitiveness. If exports do not compensate for sluggish domestic demand, the Korean economy could miss out on the general rebound in the global economy.

The challenge is to ease household and public-sector debt while stimulating domestic demand. The corporate sector and government must help stimulate demand for the time being. The best solution would be to encourage companies to invest some of their massive cash savings.

The financial crisis in 1997 that sent the country on an international bailout hunt was caused by heavy corporate debt. Companies went on a strict diet and emerged with a lighter debt burden. Despite sluggish corporate investment, the Korean economy rebounded because of debt-financed spending by households and the government. But now, it is time for a household debt diet and up to the corporate sector to help out by stimulating demand. To stimulate corporate investment, deregulation and other macroeconomic conditions must ensure profitable returns. Foreign exchange rates, wages and interest rates must be stabilized to help maintain competitiveness. The services sector should be widened to induce consumer spending.

Under the current outlook, it is best that the Korean macroeconomic policies are maintained in support of the economy. The direct incentive would be a reinvigorated real estate market. But artificial inflation in real estate assets has side effects. Korean property prices are already too expensive compared to income levels. If they go higher, asset bubbles can cause a negative effect in long-term investment and consumption.

Real estate transactions should instead be stimulated through taxation revisions. But easing mortgage restrictions could increase the already dangerously high household debt. Start-ups and mergers and acquisitions should be encouraged and the restructuring of debt-ridden or weak companies continue. Innovations in management and productivity for new growth and investment will be the key to drive the Korean economy in coming years.

Translation by the Korea JoongAng Daily staff.

*The author is a professor of economics at Sogang University.

by Cho Yoon-jae
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