[The Editors' Verdict] Time to Adapt to Changed Economic Conditions

Kim Kyung-soo, Professor Emeritus at Sungkyunkwan University

"Why are you coming out from there?"

At an economic conference held last week, a panelist sarcastically criticized the government for suddenly introducing fiscal rules in a situation that calls for more active expansionary fiscal policy. The fiscal rules proposed by the government drew cynical reactions from politicians, academia, and the media. A professor who had long been part of the government lamented that it was too late.

On the other hand, Kristalina Georgieva, Managing Director of the International Monetary Fund (IMF), recently emphasized the need to establish a four-step plan to manage the sharply increased national debt during the economic crisis caused by the pandemic. This is a point where the government's proposed fiscal rules cannot be simply dismissed.

At the conference, a presentation titled "The Law of 1% Decline Every 5 Years" caught attention. It claims that since the late 20th century, the Korean economy’s growth rate has been trending downward by 1% every five years. Strong stimulus policies by successive governments have failed to stop this trend, and it would not be surprising if the growth rate soon enters the 0% range. The presenter derived this law from the growth decline patterns of several advanced countries ahead of Korea.

Like the law of diminishing returns or Okun's law, a "law" is an economic phenomenon recognized empirically though it cannot be proven. Assuming this law holds, it can be inferred that successive governments increased government spending to prevent the growth rate from (trend-wise) declining. In fact, the five-year moving average share of government expenditure in nominal Gross Domestic Product (GDP) increased by nearly 50%, from 10.6% in 1999 to 15.8% in 2019, and the government sector’s contribution to growth rose from 0.7% to 1%. Although the growth rate declined, the government’s contribution to growth increased. Of last year’s 2.0% economic growth, the government’s share was as high as 1.6%. During the same period, the moving average of the national debt-to-GDP ratio rose from 14.6% to 36.3%.

The monetary authorities must have also faced relentless pressure to lower interest rates. This is well reflected in the velocity of money, which measures how actively money circulates in the real economy. The velocity of money, calculated by dividing nominal GDP by the broad money supply indicator M2, has fallen sharply, and the decline is more severe than in other advanced countries such as the United States. In response to low growth, the Bank of Korea lowered interest rates, but the money released increasingly flowed into the financial sector, such as asset markets, rather than the real sector engaged in production activities.

The long-term trend of growth depends on supply rather than demand, with productivity as the key determinant. The total factor productivity growth rate of the Korean economy (a core productivity indicator measuring the contribution of production factors such as labor and capital to GDP), published by the Organisation for Economic Co-operation and Development (OECD), has shown a free fall since the 2010s. Productivity stagnation also commonly appears in domestic literature based on microdata by firm and industry. Productivity stagnation is occurring across a wide range of firms, mainly in manufacturing.

According to the experience of advanced countries ahead of Korea, the industrial structural transformation in which the production share of manufacturing declines and the share of services increases significantly during the economic growth process appears as a standardized pattern. This means that as the economy matures, the growth engine shifts from manufacturing to services. However, such an industrial structural transformation is not visible in the Korean economy. Although the production share of manufacturing is stagnant, there is no clear decline, and the service sector is also stagnant without showing a clear upward trend.

It is uncertain whether the "Law of 1% Decline Every 5 Years" will continue to hold in the future. However, what is certain is that growth rates inevitably decline as the economy matures. Economic agents must lower their expectations and adapt to the changed economic conditions. Fiscal soundness alone is no longer sufficient. It is time for the government to consider where to prioritize and how to efficiently execute the budget.

Kyungsoo Kim, Professor Emeritus, Sungkyunkwan University

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