Decrease in the Growth of Domestic Demand in Korea

Abstract

(ProQuest: ... denotes formulae omitted.)I. INTRODUCTIONThis paper investigates why the domestic demand growth in Korea has significantly slowed down after the East Asian financial crisis in 1997. The average growth rate of the Korean real GDP is about 9.4% in 1981-1995 before the East Asian financial crisis but about 3.7% in 2003-2014 after the crisis as well as the credit card lending boom period of 1999-2002.1 The average growth rate is about 2.5 times greater in the former period than in the latter period. Coincidently, the average growth rate of the Korean real domestic demand on domestic goods is about 8.9% but -0.3%, respectively, in the corresponding periods. This long-lasting dramatic decline cannot be attributed to the elements that are closely linked to short run economic fluctuations. Instead, some domestic and/or foreign structural factors would induce the significant decline in the growth of the two variables. This paper intends to identify those structural problems of the Korean economy.We consider two structural problems of the Korean economy since the crisis2: one is the dampened ripple effects from the export sector and the other is the decrease in the growth of household real disposable income. We broadly define the ripple effects from the export sector: As firms export more and more, they would use more production inputs such as capital and labor, resulting in increase in investment and employment. In addition, the earnings from exports can be invested in other industries for expanding their business group, which contributes to generating many job opportunities (e.g., refer to Korean large-sized firms' investment behavior in the past and Google's investment in automobile industry). In this sense, the ripple effects are closely associated with firms' investment behavior.Our starting point for the identification of the structural problems is to pay a particular attention to the link between the GDP growth and the domestic demand growth: both growth rates have significantly declined after the crisis; but the magnitude of the lost growth rates in the latter period is different between the two variables. The average growth rate of domestic demand is much lower than that of GDP in the latter period, while their growth performance is quite similar in the former period. The inspection on the growth pattern of the Korean export provides a clue to the reasons for this difference since GDP is the sum of domestic demand on domestic goods and foreign demand on domestic goods (export). The average growth rate of export is about 12.8% but 9.5%, respectively, in the above corresponding periods, suggesting that the performance of the export sector has not been much worse, unlike the two variables. Further, the decomposition of the GDP growth rate reveals that the Korean economic growth in the latter period is entirely due to the growth in the export sector, while both domestic demand and export contribute to the GDP growth in the former period3: the contributions of domestic demand and export to the GDP growth rate are -0.3% points and 4% points, respectively, in the latter period, and 7.5% points and 1.9% points in the former period. As discussed in detail later, this dramatic change between the two periods is closely related to the dampened ripple effects from the export sector associated with the decrease in investment growth. Understanding what causes these dampened ripple effects and how they affect the Korean economy is one of the main objectives of the present paper.We also pay attention to the decrease in the growth of household disposable income. Its real growth rate is about 10.3% which is slightly greater than the GDP growth rate in the former period but about 2.3% which is less than the GDP growth rate in the latter period. This decrease in the growth of households income leads to the decrease both in consumption growth and household saving rate (defined by household saving/national disposable income): the real consumption growth rate is 8. …