Rapid Economic Recovery Welcomed... But Limited Trickledown Effect Expands 'K-Polarization'

Bank of Korea '2021 Q1 National Income (Provisional)'

Exports grow 2.0%, manufacturing 3.8%, while services grow only 0.7%

Accommodation and food service industry declines 5.4% quarter-on-quarter

Pent-up consumption occurs but only in large corporations like marts and department stores

Small-scale self-employed businesses continue to suffer

Global economic recovery drives raw material price surge

Rising inflation and interest rates increase debt risks

[Asia Economy Reporters Kim Eunbyeol, Jang Sehee] The Bank of Korea’s preliminary GDP growth rate for Q1, announced on the 9th, was revised upward from the flash estimate (1.6%), strengthening expectations that this year’s economic growth rate will exceed 4%. This confirms that the pace of Korea’s economic recovery is faster than initially expected, reflecting trends in production and other industries. However, recovery speeds vary by sector, and with rising inflation, concerns are growing that vulnerable groups such as low-income and small-scale self-employed businesses, which rely on debt, will face shocks proportional to the growth rate.

Large-scale service sector still under shock while inflation rises

The upward revision of the Q1 growth rate was largely due to industrial activity and exports. However, recovery showed differences across sectors. According to the Bank of Korea’s “Preliminary National Income for Q1 2021,” the manufacturing-led recovery was prominent. Manufacturing grew 3.8%, driven by strong performance in transportation equipment, computers, electronics, optical devices, and chemical products, whereas the service sector, centered on wholesale and retail, accommodation and food services, and finance and insurance, grew only 0.7%. Although negative growth has ended since Q2 last year (-0.8%), the service sector’s growth rate remains in the 0% range, much lower than manufacturing.

Wholesale and retail trade grew 3.4% due to strong automobile sales and department stores, but accommodation and food services declined 5.4% quarter-on-quarter. Although pent-up (rebound) consumption is occurring as people grow tired of social distancing measures, this consumption is mainly concentrated in large companies such as department stores and marts. The food service industry has taken a direct hit from COVID-19. This means small-scale self-employed businesses have not benefited from the economic recovery. Meanwhile, finance and insurance (2.6%) and information and communication (2.2%) sectors maintained growth rates in the 2% range, while culture-related sectors shrank by 2.3%. Professor Ha Jun-kyung of Hanyang University’s Department of Economics said, “Since the trickle-down effect in our economy has weakened, even if exports do well, domestic demand does not follow. Subjectively, the domestic demand side continues to face difficulties.”

As the global economic recovery continues, rising raw material prices push inflation up, which could worsen the perceived economic situation. According to Statistics Korea, the consumer price inflation rate in May rose 2.6% year-on-year, marking the highest level in over nine years. Professor Ha added, “If domestic demand does not recover and inflation rises, the perceived economic situation cannot help but worsen.” The GDP deflator, which represents Korea’s overall price level, also rose 2.6% in Q1, the highest since Q3 2017 (3.7%).

Bank of Korea cites “cyclical factors” amid improved distribution indicators

The Bank of Korea announced that last year’s labor income share improved to 67.5%, the highest level ever compared to 66.4% in 2019. However, this was the result of government fiscal intervention rather than market functions, indicating significant government influence.

Regarding this, the Bank of Korea noted that labor income share tends to improve during economic downturns. Park Yang-su, head of the Bank of Korea’s Economic Statistics Department, explained, “Corporate operating surpluses decreased, but companies maintained their workforce, and workers resisted wage cuts, so wages did not fall easily.” The improvement in the distribution ratio was due to less wage decline and a combination of government fiscal responses.

The government, however, took a positive stance. Deputy Prime Minister and Minister of Economy and Finance Hong Nam-ki praised the upward revisions of economic growth rates for Q1 this year, last year, and 2019 as a “triple level-up” on his Facebook page. Regarding the labor income share, he said, “It is due to efforts by companies and the government to maintain employment, which helped employee compensation maintain a slight upward trend.”

Meanwhile, last year’s per capita Gross National Income (GNI) was $31,881 (KRW 37.62 million), down 1.0% from the previous year in US dollar terms, marking a decline for two consecutive years. However, due to the exchange rate rising more than 1%, it increased by 0.2% in Korean won terms.

Increased debt due to prolonged COVID-19... could become a risk factor if interest rates rise

Although sectoral disparities remain, the economy is rapidly improving according to indicators, increasing the likelihood that the Bank of Korea will raise the base interest rate within the year, possibly as early as Q3.

Professor Ahn Dong-hyun of Seoul National University’s Department of Economics expects the recovery to continue in Q2, considering the pace of vaccinations, and said, “Since the economy shrank due to the virus rather than a typical recession, growth may take a different form from past economic cycles.”

Considering economic recovery and inflation, the biggest risk factor if interest rates rise is the already expanded debt. According to the Bank of Korea, household credit outstanding reached 1,765 trillion KRW at the end of March, the largest since statistics began in 2003. Professor Ha said, “Household and small business debts are steadily increasing, posing a risk. If debt burdens increase during the process of raising interest rates, it would be advisable to use fiscal policy to increase the capacity to repay debt.”

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