[Insight & Opinion] Inflation Has Peaked, But...

[Asia Economy] The US interest rate hikes are nearing their final stages. Although the US Federal Reserve (Fed) states that the inflation rate remains ‘too high,’ the US Consumer Price Index (CPI) inflation rate in December last year was 6.5%, the lowest since October 2021. The value of the dollar has been declining since October last year. The drop in the dollar’s value suggests that the US interest rate hikes will soon come to an end.

The situation is similar for us. The Bank of Korea has been raising the base interest rate since August 2021, but the 3-year government bond yield has been falling since October last year. It appears that Korea’s interest rate hikes are also in their final phase. Of course, inflation rates in both the US and Korea have not yet fallen to target levels. However, the peak has passed, and inflation caused by excess liquidity and energy shocks has begun to subside. Does this mean we can now put aside worries about inflation? It does not seem so. Structural changes are occurring in the global economy.

First, there is the issue of supply chain restructuring being pursued by the US. Due to conflicts between the US and China, ‘friend-shoring’?rebuilding supply chains among friendly countries?has begun, emphasizing stability as much as efficiency. Multinational corporations that have built production bases in China over the past 20 years now have to establish them again in other regions. Rebuilding supply chains increases costs, which contributes to inflation. Energy transition is also exerting inflationary pressure. Despite the sharp rise in natural gas prices, carbon neutrality policies have a significant impact. The energy transition to address the climate crisis is likely to act as a new form of trade barrier, especially for emerging countries. Europe’s carbon border tax is an urgent issue, and the ‘RE100’ initiative demanding 100% renewable energy also raises production costs.

The variable expected to cause the greatest shock is the demographic issue. Globally, the proportion of the working-age population is decreasing due to aging. China’s population decline and aging are particularly critical. The biggest change in the global economy since the 1990s was the industrialization of emerging countries, including China. China alone more than doubled the labor supply available for manufacturing production. However, China’s population growth has ended. According to China’s National Bureau of Statistics, the population at the end of last year was 1.4118 billion, a decrease of 850,000 from the previous year. Considering the effects of aging, China’s population decline means that 5 to 10 million people disappear from the global labor market annually.

Of course, there are places with potential to replace China. India is a prime example. While China’s population is declining, India’s population continues to grow, and India is expected to surpass China’s population within this year. India is also younger compared to China. Half of India’s population is under 30 years old. India’s median age is 28.4 years, more than 10 years younger than China’s. However, having a large population does not automatically make a country a manufacturing base. Although India is an IT powerhouse, its manufacturing base is weak. Above all, infrastructure is severely lacking. Regulations are complex, and decision-making is slow. Ethnic and religious conflicts are serious. Unlike China, India’s government lacks the capacity to mobilize human capital for economic growth. India’s economic power is still less than one-fifth of China’s. It will take time for India to replace China as the ‘world’s factory.’

Inflation has peaked, and interest rates have risen as much as they can. However, the US-led supply chain restructuring overlaps with energy transition and China’s population decline. It seems difficult to expect a return to an era of low inflation.

Kim Sang-cheol, Economic Commentator

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