[Insight & Opinion] South Korea's Economy Trapped in the Pitfalls of Politicization

Political Influence on Economic Policy Cannot Be Excluded
Interest Rate Policy Also Closely Linked

Recently, the government and the ruling party postponed the increase in electricity and gas prices. They did not want to take responsibility for all the public utility price hikes that were not implemented by the previous administration, as it would increase public dissatisfaction. Additionally, the opposition party, which holds the majority in the National Assembly, passed an amendment to the Grain Management Act that requires the government to purchase all surplus rice, mindful of farmers' votes ahead of next year's general election. These decisions were driven more by political considerations than economic factors.

Economics and politics are closely intertwined, making it difficult to completely exclude political influence from economic policy. In particular, interest rate and fiscal policies are closely linked to election outcomes. A sharp increase in interest rates may curb inflation but also raises household interest burdens and leads to economic recession and corporate bankruptcies, thereby lowering voter support. This can cause the ruling party to lose elections. For example, during the second oil shock in 1979, Paul Volcker, Chairman of the U.S. Federal Reserve, raised interest rates sharply to reduce inflation, but the resulting recession and corporate failures increased public dissatisfaction, leading to President Jimmy Carter's failure to secure re-election.

In South Korea, the Roh Moo-hyun administration raised interest rates by 1.75 percentage points in 2005 to curb housing prices, but faced political difficulties due to the ensuing economic downturn. Similarly, the current administration raised interest rates by 2 percentage points after taking office to reduce cost-push inflation caused by rising international oil prices. However, over the past year and a half, a 3 percentage point increase in interest rates has increased the interest burden on ordinary citizens and caused real estate prices, which account for more than 70% of household assets, to plummet by over 30%.

Small business owners and SMEs, who endured the COVID-19 crisis, are now unable to withstand the high interest rates and face the risk of bankruptcy, increasing the risk of a financial crisis. Excessive interest rate hikes lower the approval ratings of the government and ruling party and may negatively impact next year's general election. This highlights how crucial the Bank of Korea's interest rate policy and the Monetary Policy Committee, which decides on it, are not only economically but also politically.

Fiscal policy is also deeply connected to politics. Increasing populist, vote-winning fiscal expenditures can yield favorable election results. For this reason, many emerging market countries prefer expansionary fiscal policies before elections. Conversely, governments and parties that raise taxes often lose elections.

Institutional reforms related to the economy are also influenced by political factors. The government is promoting three major reforms: labor, pension, and education. From an economic perspective, labor reform to enhance industrial competitiveness and increase employment, pension reform to avoid pension depletion, and education reform to nurture talent for new growth industries are essential. However, politically, active promotion before next year's general election is difficult. Opposition from interest groups that suffer losses from reforms can negatively affect elections. In past administrations, although the necessity was acknowledged, political factors were the main reason for failure to implement these reforms.

Unlike in the past, the politicization of the Korean economy is rapidly advancing. Interest rate and fiscal policies, as well as agriculture, education, pension, and labor policies, are all strongly influenced by politics. This is due to significant changes in our political environment. Excessive politicization of the economy is undesirable. Populism that increases fiscal spending leads to fiscal deficits and national debt, and overly expansionary monetary policies cause inflation, potentially resulting in repeated foreign exchange crises like those in Latin America. However, when politics dominates economics and the economy is already trapped in politicization, it is not easy to escape this trap. To forecast the Korean economy and propose appropriate solutions, it is necessary to face the reality of our increasingly politicized economic policies.

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