"When Fiscal Spending Increases by 100 Trillion Won, Growth Rate Falls by up to 0.38%p"

[Asia Economy Reporter Changhwan Lee] An analysis has emerged suggesting that significantly increasing fiscal expenditure could lead to a long-term decline in the Gross Domestic Product (GDP) growth rate. There are concerns that a rapid expansion of government finances may damage long-term growth momentum.

The Korea Economic Research Institute (KERI) forecasted on the 23rd in its report titled 'Fiscal Multiplier Effects Including Funding Sources' that if fiscal expenditure increases by 100 trillion won relative to GDP, the long-term growth rate could decrease by 0.18 to 0.38 percentage points (p).

The report pointed out that considering the cost of funding, it is difficult to stimulate the economy in the short term through expanded fiscal spending, but the bigger issue is the damage to long-term growth momentum.

The report warns that it is difficult to stimulate the economy in the short term through expanded fiscal spending, but the bigger problem is the damage to long-term growth momentum.

Using data from 28 advanced countries between 1980 and 2019, the report estimated the short- and long-term growth elasticities of fiscal expenditure according to funding methods. It estimated that when funding is secured through fiscal deficits, the long-term growth elasticity of fiscal expenditure ranges from -0.34 to -0.073.

This means that expanding fiscal expenditure by 100 trillion won (5.2% of the nominal GDP of 1,914 trillion won in 2019) could reduce the long-term growth rate by 0.18 to 0.38 percentage points. Meanwhile, when funding is secured through tax increases, the long-term elasticity is negative but statistically insignificant, according to the report.

The report stated that when funding is secured through fiscal deficits, the short-term growth elasticity of fiscal expenditure is estimated at 0.016, but when funding is secured through tax increases, the short-term growth elasticity is estimated at -0.012.

Expanding fiscal expenditure by 100 trillion won through government bond issuance is expected to raise the current growth rate by 0.08 percentage points, but if funding is secured immediately through tax increases, the growth rate is projected to decline by 0.06 percentage points, the report forecasted.

The report explained that tax increases have a short lag between fiscal expenditure and funding timing, whereas fiscal deficits have a longer lag, so short-term economic stimulus effects may occur. However, since government bond issuance leads to increased future tax burdens, its negative impact on long-term growth rates is greater than that of tax increases.

Generally, since funding tends to be secured by combining government bond issuance and tax increases, the report pointed out that there is no short-term economic stimulus effect from fiscal expenditure, but the long-term costs to be borne are significant.

KERI warned that the phenomenon of a negative Keynesian effect, where the fiscal multiplier turns negative, is expanding, and if fiscal expansion policies continue, low growth could become structurally entrenched. The fiscal multiplier is an indicator showing how much GDP increases when fiscal expenditure increases by one unit.

The report argued that currently, as market anxiety about policies spreads, even if the government increases spending, the frozen private consumption and investment sentiment are not thawing, making policy revision and restoration of policy trust urgent.

It also noted that with the rapid increase in national debt, concerns about future tax burdens are growing, and rising market interest rates are causing a crowding-out effect that reduces private consumption and investment.

In recent years, public investment and public jobs have expanded, but the report pointed out that this results in transferring resources from productive sectors to unproductive ones, which could prolong the economic downturn.

Moreover, since South Korea has a high dependence on external trade, a significant portion of fiscal expenditure is spent on imported goods, so fiscal spending does not help stimulate the economy and instead worsens the current account balance, the report analyzed. It also claimed that because South Korea has a high proportion of tax revenues from inefficient tax items such as corporate tax and property tax, the 'negative Keynesian effect' is more pronounced compared to other countries.

Cho Kyung-yeop, head of the Economic Research Division at KERI, emphasized, "The biggest problem with expanding fiscal expenditure is the loss of opportunities for structural adjustment," adding, "The economic recession period should be used as an opportunity to correct errors and overinvestment and to venture into new fields." He stressed, "Rather than expanding fiscal expenditure, improving the domestic investment environment through increasing labor market flexibility, deregulation, and corporate tax cuts is the shortcut to overcoming the current economic crisis."

This content was produced with the assistance of AI translation services.