South Korea over the past four decades has demonstrated incredible growth and global integration to become a high-tech industrialized economy. In the 1960s, GDP per capita was comparable with levels in the poorer countries of Africa and Asia. In 2004, South Korea joined the trillion dollar club of world economies, and is currently the world’s 12th largest economy. Initially, a system of close government and business ties, including directed credit and import restrictions, made this success possible.
The government promoted the import of raw materials and technology at the expense of consumer goods, and encouraged savings and investment over consumption.
The Asian financial crisis of 1997-98 exposed longstanding weaknesses in South Korea’s development model including high debt/equity ratios and massive short-term foreign borrowing. GDP plunged by 6. 9% in 1998, and then recovered by 9% in 1999-2000 Korea’s export focused economy was hit hard by the 2008 global economic downturn, but quickly rebounded in subsequent years, reaching 6. % growth in 2010.
The US-South Korea Free Trade Agreement was ratified by both governments in 2011 and went into effect in March 2012.
Throughout 2012 the economy experienced sluggish growth because of market slowdowns in the United States, China, and the Eurozone. The incoming administration in 2013, following the December 2012 presidential election, is likely to face the challenges of balancing heavy reliance on exports with developing domestic-oriented sectors, such as services.
The South Korean economy’s long term challenges include a rapidly aging population, inflexible labor market, and heavy reliance on exports – which comprise half of GDP. South Korea is an open economic system country.
It is totally depending on their trading activities to support its economic growth as South Korea does not have any natural resources. Its main exports are semiconductors, wireless telecommunications equipment, motor vehicles, computers, steel, ships, petrochemicals and its main export partner are China 24. 4%, US 10. 1%, Japan 7. 1%.
Meanwhile, its main import are machinery, electronics and electronic equipment, oil, steel, transport equipment, organic chemicals, plastics and the import partner of South Korea are China 16. 5%, Japan 13%, US 8. 5%, Saudi Arabia 7. 1%, Australia 5% PRICE STABILITY. Export (Billion $) Inflation Rate Diagram 1 Diagram 2 Price stability is very important to a country as it determines the rate of money of the country. One crucial component that is significance to price stability is Consumer Price Index (CPI). Usually, inflation rate is based on CPI.
The South Korean CPI shows the change in prices of a standard package of goods and services which South Korean households purchase for consumption. In order to measure inflation, an assessment is made of how much the CPI has risen in percentage terms over a given period compared to the CPI in a preceding period. The price stability also is achieved when there is a low rate of inflation. According to Parkin and Bade, inflation is an upward movement in the average level of prices. Its opposite is deflation, a downward movement in the average level of prices.
The boundary between inflation and deflation is price stability. Therefore, it’s very important for a country to control their inflation rate from 2% to 3% only in order to have good price stability. However throughout the 5 years period starting from 2007 until 2011, Korea’s average inflation rate is 3. 4% which is quite high as the inflation rate should be only 2% to 3% only. This is due to the deepening recession that occurs during late 2008 and 2009 in United States and in the world generally which causes the economic activity become slower.
In United States, as the collapse one of the biggest investment bank Lehmann Brothers had struck down South Korea’s burgeoning economy. South Korea is an export oriented country which mean that they totally dependent on export for their economic activity. As United States is one of the largest import partners of South Korea, so it will directly affect South Korea’s economic activity. A huge declining in demand for computer and home appliance which are the major sector in South Korea’s export about 50. 6% respectively from the same period last year has given huge impact of downturn to South Korea’s economy. Read about achievements of Africa before European arrival
In fact, due to recession, key automotive industry like Hyundai suffered as customers in the U. S. and Europe cut back on buying and spending on the car. Meanwhile, as illustrated in Diagram 2, there is sharp decrease in South Korea’s inflation rate during 2009. It is because of the shrunk in the economy, following in the steps of United States, Japan and Europe. Economic crisis occurred in late 2008 and earlier of 2009 because of easy credit policy by United States to increase homeownership rates among low income earners. A huge portion of the increased mortgage loan defaults are what are referred to as ‘sub-prime’ loans.
Most of the sub-prime loans have been made to borrowers with poor credit ratings, no down payment on the home financed, and no verification of income or assets. Lastly, the result was collapsing of financial institution and affects the world economy too as stock markets around the world plummeted. Eventually, South Korea face the same problem too as their export activity fell down. People also start to reduce their spending as they receive lower income and some of them might lose their jobs as the firms are going to reduce their production due to less demand for goods because of recession.
Furthermore, firms will try to cut off their cost of production by firing workers to meet their financial plan. As people earned less income, therefore the consumption also will be decreased and demand for goods also will decreased. This will result the shifting of Aggregate Demand to the left that eventually will reduce the production of goods and decreased in the price of goods. On the other hand, domestic economic activity will slow down and GDP also will be decreased.
Take a look at Graph 1 for better understanding.
Based on the graph, it clearly states that consumption really give a huge impact to the aggregate demand (AD= C+I+G+(X-M)) as less in consumption will shift AD to the left resulting the price of goods decrease and decreased in GDP. Graph 1 During in 2009 until 2011, it shows that South Korea managed to recover well from the recession as the trends keep increasing onwards. This happen due to economic policy that was implemented by the government which was fiscal stimulus plans. South Korea had used different combinations of government spending and tax cuts to boost the economic growth.
It is based on the Keynesian theory that deficit spending by governments can replace some of the demand lost during a recession and prevent the waste of economic resources idled by a lack of demand. Thus, this will shift the AD to the right and increase the inflation rate back. Graph 2 FULL EMPLOYMENT Full employment is very important and each country dream to achieve it as full employment has very close relation to the goal of efficiency in resources allocation and achieving a good Non-Accelerating Inflationary Rate of Unemployment (NAIRU).
Full employment means that every people in the labour force are employed in the most economically efficient way. Unemployment rate is the indicator of full employment. Unemployment rate can be defined as a rate of people in the labour force who are currently not being employed but actively looking for jobs. Diagram 3 Based on the graph, the trend for unemployment rate in South Korea for the past 5 years is fluctuating. As we can see in the year 2007 to 2008, the unemployment is decreased because of high inflation rate and good economic growth.
But in 2009, the unemployment rate is at the peak which about 3. 7%. This happened due to global recession that occurs during that year. Although South Korea’s unemployment rate is not very high as the NAIRU is 5%. Therefore, when the rate is still less than 5% yet it is still acceptable. From the analysis conducted, it seems that South Korea still had to bear the cost from the increased unemployment rate as it rose up to 0. 5% from 3. 2% to 3. 7%. This happened due to South Korea’s economy where they are totally depending on their trading activities as they do not have any natural resources.
It proves when South Korea’s export in 2008, declining from 433. 5 billion to 373. 6 billion which approximately about 59. 9 billion USD (Diagram 3). This somehow does not affect the economy much as South Korea’s government had imposed strategic economic plan in order to minimise and escape from the global recession in 2008 when they increased in domestic production and encourage the people to change a new car in order to boost the economy. It is called ‘cash for clunkers’ program that will give a tax break of 2. million won ($1,900 USD) to drivers who replace a car nine years old or older with a new car. Therefore, it is assumed that slightly increased in unemployment rate is because of the declining in demand for other sector like fabrics, telecommunication and sound equipment, metal goods, electronics, chemicals and steel from other country. Due to that, the firms need to reduce the labor force as the productivity is fall and eventually shifting the AD to the left. This is the reasons why the unemployment rate increase as the unemployment gap had increased. Graph 3
Labour Force Participation Rate (Female) Diagram 4 Labour Force Participation Rate (Male) Diagram 5 As shown in the Diagram 4 and 5, it shows that the labour force is dominated by the male worker. This is because female worker in South Korea tend to stay at home and take care of their child more than involve in the labour force. Furthermore, working hour that is very high in South Korea which is about 2357 hours. This somehow, become difficulties for female to enrol in the labour force. Thus, it will be wasted as the labour resources is not fully utilized.
In instance, South Korea need to impose new policy in order to boost the skilled labour force like reducing the working hours, and improve the parental leave system might encourage some of these skilled female into the work force. ECONOMIC GROWTH Economic growth in the economy is measured by Gross Domestic Product (GDP). GDP measure the monetary value of all final goods and services produced in a country over a specified of time. Economic growth increase the productive capacity of an economy, they are allowing more wants to be satisfied.
In South Korea, the annual growth rate in GDP measures the change in the value of the goods and services produced by the country’s economy during the period of a year. GDP Per Capita Diagram 6 Diagram 7 Based on Diagram 5, it shows that before the year 2009, the economic growth of South Korea is steadily around 4% to 5%. But during 2009, the economic growth trend is decreasing dramatically until 0. 1%. After that, in 2010 onwards is the recovery phase. In 2009, the economic growth shows the decreasing trend from at a steady rate of xx in the previous year until 0. %. This is because of the global recession that affects South Korea’s economy. As South Korea’s economy is based on trading, many trading partner especially in US and Europe decline their demand for South Korea’s goods. This has given a huge impact towards South Korea’s export. On the other hand, the reducing of export which is the main sources of income in South Korea had made the economic growth slowdown. With that, it also shifting the AD to the left as export is one of the component in AD (AD= C+I+G+(X-M)).
However, South Korea is very lucky as it is one of the countries that had a narrow escape from the recession crisis in 2009; the economic growth of Korea in that year is 0. 1%. This is one of the great achievements as other countries that had faced the same problem did not manage to escape from having a negative economic growth. The main reason South Korea managed to have a narrow escape because of the genius action taken by the government in order to increase the people’s consumption. The government of South Korea had imposed ‘cash for clunker’ program and enacted fiscal stimulus plan. Cash for clunker’ is a program that will give a tax break to drivers who replace a car nine year old or older with a new one. This eventually had boost Hyundai and Kia, South Korea’s national car sales from 530,000 to 580,000 and from 327,000 to 357,000 respectively. These are the reasons why South Korea had an increasing trend for their GDP per capita although the real GDP is decreasing. Next, due to the global recession in 2008, South Korea’s government had announced a massive $120 billion bailout package and followed with another $11 billion infusion in the form of tax cuts and other stimulus.
Then, another $21. 6 billion supplementary budget announced in March 2009 which enabled the South Korea’s economy to narrowly avoid recession in the last quarter of 2008 when it grew just 0. 1%. With that, it is the worst performance since the Asian financial crisis when the country contracted 6. 95% for the year in 1998. EXTERNAL BALANCE External balance means a balance between money inflow and outflow resulting from a country’s transactions with the rest of the world. It is a record of a country’s transaction in goods, services and assets with the rest of the world.
The external balance objective is to achieve enough inflow from foreign country to buy imports and also being able to meet its financial obligation to other country. There are three main components in external balance which are the current account deficit as a percentage of GDP, net foreign debt as a percentage of GDP and the exchange rate. Current account as a percentage of GDP. Current Account Balance (US$)| Diagram 8 Referring to Diagram 7, it shows that South Korea always had current account surplus until 2008, where it experienced current account deficit for the first time since 2004 to 2011.
This is probably because of the rising cost of commodities imports like oil just as exports started to slow. South Korea is the world’s fifth-largest importer of crude oil. Therefore, the global crisis in 2008 highly affected South Korea as the supplier of oil to South Korea which is US reduced their export of oil. As the world having low supply of oil, the price commodity of oil rose up. This had increase South Korea’s import as they need to pay more for oil crude. Furthermore, exports of South Korea declining in 2008 had made the condition become worse. Exports (Billion $) Diagram 9
Imports (Billion $) Diagram 10 During 2009, the current account is at peak which is about 42. 67 billion. This is probably the effect from the government action that encourage people to buy new car by giving tax break that eventually managed to increase the sales of the cars. Furthermore, the Free Trade Agreement by South Korea and US had boost exports by billions of dollars annually for both sides. With the agreement, South Korea had the advantage to the US and EU for a long period since it will not be easy for other countries to forge Free Trade Agreement with both of the two world’ largest markets.
The free trade pact will help expand the trade volume between Korea and the United States, create more jobs, and strengthen the industrial competitiveness of the two countries. It is very beneficial as there is no tariff for its import on agricultural products from the US. Moreover, it becomes cheaper for people in South Korea to buy quality goods from US. These are the reasons the import and export of South Korea have increasing trend starting 2009 onwards. Foreign Debt as a Perncentage of GDP Debt – external (Billion US$) Diagram 11
A country’s external debt is the total debt owed by a particular country overseas less total debt owed by foreigners to that country. During 2009, the external debt had increased significantly. This is because South Korea had made loan for their bailout from the global recession in the late 2008. South Korea’s government had injected billions of dollars to boost the economy. The bailout plan was succeed as South Korea escape from the recession and the recovery phase occurred as the economic growth increased and the external debt decrease slightly in 2010 indicates that the economy of South Korea become better.
Exchange rate Diagram 12 In Diagram 10, by the year 2009, it shows that there was a very high depreciation of the currency in South Korea which is won. It depreciates approximately from 1,100 won to 1,276 won. This is probably because of deepening recession in the world had caused inflation to occur in 2008. Due to that, people might start to buy foreign goods rather than local one as imported goods is cheaper. PS Money outflow S2 Depreciate D Money inflow Graph 5 Higher amount of money flowing out from country will increase the supply of the currency and will result in shifting Supply Curve to the right.
When this occurred, the currency of South Korea’s Won will depreciate. Economy Prospect Based on my analysis, South Korea’s economic growth will continue growing in a long term as it has a good and wider opportunity to expand their economy. Besides, the government also must know the right time to implement the policy according to the situation weather it is contractionary or expansionary policy. For its population, in the future South Korea will have more elderly than the younger people due to low birth rate and high life expectancy. This is because of the better life style, higher incomes and improves medical acility. It is feared that in 2050, there will be seven over-65s for every ten working-age adults. Disproportionate old-age poverty would have a huge impact on the social backing for policies designed to foster growth. South Korea also will be faced the problem of shrinking of population because of the young people who tend to delay their marriage and plan the family member. Furthermore, South Korea also need to aware the inflation rate of the country as if South Korea country is experiencing long periods of low inflation, this country will likely to have a low interest rate.
Then, low interest rates means low gains for domestic financial securities which mean less people will demand it thus the currency will likely to depreciate. If this happens it will have a negative impact on the trade balances. For the exchange rate, it seems that its currency will keep appreciating for some times. However, the government needs to take some action if fluctuations in exchange rate occur in order to make it stable as depreciation will make the current account deficit to occur. Based on my findings, South Korea will have positive net income transfer because of it strong currency.
Thus, it will benefit them as imported products become cheaper and they also can served their debt from the loan for the bailout quickly as they had did it during 1997 crisis. However, it seems that exports will still be the main source of income to South Korea as the Free Trade Agreement with US will surely enhance the export. It is because they have the advantage in the US and EU because low of tariff charged will make the export goods from South Korea become more competitive with the local goods.
Thus, it will increase the exports sector. Conclusion As the conclusion, South Korea is a country that has very good economic condition and system. Most of the macroeconomic objective is achieved by South Korea. It also should be the example for other countries on their economic management. One thing that the South Korea’s government need to pay additional attention is about their population growth and labour force participation rate especially for female. Other than that, South Korea had managed to take care their economy very well.