Fiscal integrity matters
The author, former chief economist at the Asian Development Bank and a senior adviser for international economic affairs to former President Lee Myung-bak, is a professor of economics at Korea University.
What will happen if the government keeps stockpiling debt and lets deficit run unabated? The bill on our debt binge will arrive one day. Should we be worrying about our future capacity to pay off the debt, or the sustainability of public finances?
Many have been raising the alarm about our snowballing debt and worsening fiscal integrity. According to the International Monetary Fund, the government debt-to-GDP ratio, which stood at 40 percent in 2018, shot up to 51 percent in 2021. The ratio is projected to reach 67 percent by 2026. Government debt surged over the last two years to help fight Covid-19. Since presidential candidates are vying to raise spending further, the growth in our fiscal deficits and government debt are expected to accelerate. Candidates promise expensive platforms such as basic incomes, a spike in monthly salaries for military conscripts, and an increase in basic allowances for the elderly to win votes in the March 9 presidential election.
Korea’s debt level currently is manageable. Other developed economies spent more during the pandemic, and their government debt-to-GDP ratios have also risen. The ratio averaged 83 percent in 2021 among 35 developed economies. South Korea’s figure remains relatively low. The financing cost for outstanding government bonds also is low.
Aggressive fiscal management is advisable despite a surge in government debt when the economy is in trouble. People must be subsidized for a lengthy battle with Covid-19. The government should be covering basic livelihoods of the people and bolstering welfare benefits for the socially weak.
Korea’s growth potential is expected to weaken due to a working population thinning out from low birthrates and fast aging coupled with stagnated productivity. The government has the duty to buttress producing capacity and growth as well as enhancing the social infrastructure and promoting new industries. Excessive taxes burdening the private sector should be eased to motivate labor and investment as well as innovation.
Trying to bolster growth through fiscal spending is a populist move. To avoid unproductive spending, the government must be scrupulous in its budgeting and executing process for efficient fiscal management. During the American Economic Association’s annual meeting in January, former U.S. Treasury Secretary Larry Summers agreed that fiscal policy should act to help the country, but pointed out “the devil is in the detail.” Spending should go to reinforcing infrastructure and addressing climate change and other social projects as well as promoting technology and innovation. But the government must be careful so as not to waste tax funds and stoke inflation.
Korea’s government debt won’t reach dangerous levels even if the incoming government keeps on with aggressive spending upon the inauguration of a new president in May. But the fast pace of growth in debt could threaten sustainability in the mid-to-long term. According to the National Assembly Budget Office, government debt could top 100 percent of GDP by 2040. In 2039, the national pension fund balance would run into a deficit, adding more speed to government debt growth. By 2060, the fiscal deficit could exceed 10 percent of GDP with the government debt-to-GDP ratio reaching 159 percent.
Government debt could surge staggeringly if faced with a serious economic or security crisis. Investors would become wary of the government’s debt financing ability and shun their purchases of government bonds, which could further raise interest costs. The central bank could buy government bonds like Japan, but such an act can cause an increase in monetary supply to fan inflation or create bubbles in assets.
Unlike the U.S., Japan and euro nations, South Korea’s currency is not internationally tradeable. Its foreign exchange and capital markets are susceptible to foreign capital flight. When the Korean won crashes, another financial crisis is inevitable. The IMF’s Asia Pacific director has warned that the judgement on whether South Korea is okay with the surge in its debt-to-GDP ratio depends on the international market.
Reform is necessary to ensure long-term viability of public finances. If the debt binge continues, future generations will pay more taxes to pay off the debt or settle for paltry pensions. There must be a mid-to long-term outline to reform taxation and pension systems and raise the efficiency of spending. The government must expand its tax revenues, adjust pension payouts and premiums, and study the economic feasibility of fiscal spending carefully.
A fiscal role is essential during crises as seen in the battle with Covid-19. A new government must consider mid-to long-term fiscal integrity when drawing up and administering budgetary spending. The new leadership must muster capabilities of the government, National Assembly, and think tanks for smarter fiscal management.
Translation by the Korea JoongAng Daily staff.