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A decade has passed since the global economy went into one of the worst economic crises in modern economic history. With the exception of the Great Depression of the 1930s and the Global Crude Oil Shock during the 1970s, there has not been any example when the global economy faced such a crisis. The 2008 Global Financial Crisis started with the US Sub Prime Mortgage Crisis in the US banking system and later spread to the rest of the world. Most of the economies including the East Asian economies like Japan and South Korea went into recession after 2008. India was among the few economies in the world which did not face recession but still went through a prolonged slowdown. A detailed analysis of the reasons and events which led to such a crisis and how did it impact South Korea and India has already been discussed by the author in another paper.
South Korea was having exposure to the risky securitized instruments issued by the US financial institutions in 2008. Thus, when the housing and other asset prices declined in the US, the value of securitized instruments related to these assets also declined and South Korea also faced a parallel fall in these asset prices. The crisis then spread to their banking sector drying up the credit flow and raising the interest rates. South Korea, being an export-driven economy faced a further fall in their GDP growth after a drastic fall in global demand for exports in the aftermath of the global crisis. Foreign investment also went out in massive amounts leading to stock markets crashing and leading to Won depreciation. The immediate impact of the crisis was relatively less severe on the Indian economy. One reason for this was the lack of exposure to the risky securitized instruments of the US due to better regulation of the open economy by the Reserve Bank of India. India is also not as dependent on exports as South Korea. However, exports of modern services to the European countries and the US reduced after the crisis thereby causing lower GDP growth. Also, being a popular destination of foreign investment India also faced significant foreign capital outflows from stock markets leading to falling in share prices and rupee depreciation.
Like most developed economies after the 2008 crisis, South Korea also responded by a number of expansionary monetary and fiscal policies to revive GDP growth. With a drastic fall in interest rate from 5.25% in October 2008 to about 2% in February 2009, South Korea recorded the lowest real interest rates among all developed economies like US, UK, EuroZone, and Japan. Through a mix of government expenditure and tax cuts, South Korean fiscal policy was three times more expansionary in 2009 as compared to 2008. GDP growth which was already decelerating from 5.5% to 2.8% from 2007 to 2008, further reduced after the crisis to just 0.7%. The above expansionary policies revived sharply to attain about 6.5% growth in 2010, the highest economic growth that the Korean economy experienced in the last decade. However, after 2010 average GDP growth remained around 3% per annum from 2011-2014. It has fallen below 3% per annum after 2014 with just 2.7% in 2014.
The paper attempts to find some reasons behind the economic slowdown in the last decade in general and the last three years in particular. Exports have been the mainstay of Korean economic growth since the 1960s. By 2008, before the impact of the crisis, about half of GDP was coming from exports in South Korea. After the crisis, apart from the fall in exports the share of exports in GDP also fell to about 47.5%, reaching almost the same level as pre-crisis in 2010. This share reached its peak of 56% in 2014 and declined thereafter to 44% in 2018. The exports fell in value terms during 2014-2016 even if GDP increased, although at a slower rate during this period. Thus, there still exists an overall positive correlation between the exports and GDP of the South Korean economy. However, after 2014 there is a mild diversion that can be observed between the paths of GDP and exports.
Among many reasons for the relatively flat export growth of South Korea is the change in the nature of Chinese economic growth. Once the fastest growing economy is fuelled by both consumption and investment expenditure, the Chinese economy is gradually maturing. Its demographic structure is also gradually shifting a significant part of its population to the elderly age group. Thus, its import demand has been slowing down. It must be noted that China is South Korea’s largest trading partner accounting for more than 26% of Korean exports. Further, the increasing share of these exports is related to investment rather than consumer demand. As China revises its investment expenditure downwards it reduced Korean exports to China in the post-2014 time period.
The US-China trade war has exacerbated such a situation. Under this US has been raising the import tariffs on many imports from China. That has reduced Chinese exports to the US in these sectors along with investment in these sectors. It is likely to reduce Korean exports to China further. The retaliation by China in the trade war through higher import tariffs on many imports from the US has also hurt some types of domestic investment thereby affecting demand for some from South Korea. Korean exports have also been affected by the restrictions imposed by Japan on shipments of materials related to chip and display production to South Korea. This is related to a diplomatic row between the two countries in relation to compensation of forced labor during the Second World War.
However, to measure the impact of international trade on economic growth, net exports or trade balance is often considered to be conceptually a better indicator. The trade balance had become marginally negative for South Korea in 2008 meaning thereby that the economy’s export value was less than the value of its imports, a rare phenomenon for the economy. After that it became positive and except for 2011 when it decreased significantly, it regularly increased till 2016 despite moderation in GDP growth. It has declined during 2017 and 2018, although not vary significantly, and will be a crucial indicator to watch for the economy in the future.
It can be inferred from the above findings that the importance of factors other than exports in the determination of South Korean growth is increasing even if very marginally. The standard macroeconomic theory classifies GDP from the demand side into four basic indicators viz. consumption expenditure, investment expenditure, government expenditure, and net exports. If despite improvement in trade balance till 2016, South Korea was facing an economic slowdown, it indicates some negative impact on the remaining three indicators. South Korean economic growth is fairly dependent on the consumption expenditure of both government and households apart from the exports.
In particular, household final consumption expenditure accounts for nearly 50% of GDP inclusive of expenditure on imported goods. Despite some reduction in this share, it remained slightly higher than 50% till 2014. But, after 2014 its share has decreased to about 48% by 2018. One reason behind such a fall is the overall fall in the share of national income going in the hands of the households over the last decade. When a greater proportion of income is pocketed by the firms or the companies it reduces the marginal propensity to consume in the overall economy as households are expected to spend a greater proportion of their income. Although this fall is not very significant, the distribution of such expenditure has been lop-sided over recent decades.
The changing demographic features in South Korea have impacted the distribution of income as well. With higher life expectancy over decades, the share of the elderly population has risen drastically. However, the age till which the population is economically active has not changed much. This has led to a greater focus on savings during their employment so that they can use these savings after retirement, thereby reducing their present marginal propensity to consume. Another factor which has restricted households’ consumption potential is their rising indebtedness. South Korea has its household debt to GDP ratio to be among the highest in the world. It was already near 70% in 2007 which has regularly increased to higher than 80% in 2015 and higher than 90% in 2019.
Apart from these long-term structural reasons behind lower consumption expenditure, it has also been impacted after the Sewol ferry disaster in April 2014 in which more than 300 lives were lost including that of about 200 students and teachers. It had a significant negative impact, not only on social and political aspects of the country but also slowed down the economy mainly through lower consumption expenditure as well as investment expenditure. However, there was only a temporary reduction in investment expenditure in 2014 after which has been stable and even increased during 2016-2018. Interestingly, South Korean investment expenditure did not decline much even after the 2008 crisis except during 2013. In the electrical and electronic sectors, South Korea made more investments in 2010-11 in order to come out of the crisis. Due to excess capacity built during that time, demand for equipment in these sectors became lower after 2012. Despite this fixed capital formation in the country has remained around 30% of GDP and has exceeded this level recently. Government final consumption expenditure has also remained stable. As expected during the last two years of slowdown, such expenditure increased to support the economy.
By the time this paper is going through its final revision, the entire world is facing another slowdown which may result in a global recession due to the spread of the novel coronavirus. The exact nature of the spread of this virus is still a work in progress in the medical science community. From the evidence available so far, its first victim was from the Wuhan province of China. In China the spread of the virus as recorded so far started from the end of December 2019 and resulted in around thousands of casualties within a month. Soon, the virus spread to the other Chinese provinces and then to a number of other countries, particularly in Asia and Europe over the next month. South Korea registered the first COVID-19 case on January 19, 2020. The South Korean government acted quite early to check the spread of the virus and was among the most successful countries to record only 30 positive cases till February 18 without recording any death from the virus. However, the 31st positive case in the country gave rise to its spread at a larger scale as the patient had interacted with a number of people before testing positive resulting in the community spread of the virus. Despite this, the country has been fairly successful in not allowing COVID-19 to result in a health care emergency of the scale that the European countries like Italy and Spain had to face. Over a period of three months, South Korea has managed to restrict the COVID-19 cases to about 10,000 with a little over 200 persons losing their lives due to the virus infection.
Although this paper focuses on the economic impacts of such a pandemic on the two countries, the South Korean policy to restrict this health crisis has crucial learning for economic growth in times of such health-related crises. South Korea, from its experience of controlling Middle East Respiratory Syndrome (MERS) which was also caused by a type of coronavirus, went for testing a large number of people for COVID-19. It ensured early detection of cases thereby increasing the recovery rate. Another policy which made South Korean policy unique in the context of the COVID-19 crisis is the large-scale production of diagnostic kits for the disease. It helped the country in testing as many as 20,000 persons a day during the crucial period of community spread in February and March 2020.
The production of these diagnostic kits is also being exported to a large number of countries across the world including the U.S.A, Japan, China, the U.K, France, Italy, and a number of other countries from across the world including India. Apart from South Korea very few countries like China have produced these kits on a large scale and exported them. However, recently some issues related to correct diagnosis have been raised in relation to the Chinese kits. South Korea, through its large-scale production of good quality diagnostic kits, has not only reacted timely to prevent a domestic health crisis but has also helped almost the entire world in doing so. Also, during the times when demand for almost all types of exports has been falling globally due to a lack of both supply and demand, South Korea has retained the leadership role in the export of these kits which is likely to be a silver lining in the lower economic growth problem that it is going through. The import of diagnostic kits by India from South Korea is just another chapter in the long-term trade relations between India and South Korea. In the next section, first, the performance of the Indian economy in the post-2008 time period has been analyzed. This will be followed by a discussion on how the two countries can assist each other in coming out of the economic slowdown.
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