"1%P Increase in Social Protection Spending Leads to 2.1% Decrease in Real GDP"

National Assembly Budget Office 'Macroeconomic Effects of Fiscal Expenditure by Sector'
1%P Increase in Social Protection Spending Leads to 2.1% Decrease in Real GDP
1%P Increase in Health Spending Leads to 1.5% Increase in Real GDP

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A study has found that as the proportion of fiscal expenditure for social protection, such as old age and unemployment, increases, short-term real gross domestic product (GDP) decreases. This is interpreted as social protection spending potentially causing moral hazard by lowering workers' motivation. On the other hand, increasing the share of fiscal expenditure in the health sector improves labor productivity, leading to an increase in real GDP.

According to "Macroeconomic Effects of Fiscal Expenditure by Sector," published by Jiwoon Kim, an assistant professor in the Department of Economics at Hongik University, in the Budget Policy Research of the National Assembly Budget Office, an analysis of the top 10 fiscal expenditure data from 22 OECD countries between 1995 and 2019 showed that when the nominal fiscal expenditure share for social protection increases by 1 percentage point relative to nominal GDP, real GDP decreases by 2.1% within a short-term horizon of one year.

This is because fiscal expenditure in the social protection sector is generally focused on income support and income replacement, which can reduce workers' motivation and decrease labor supply. However, the report evaluated that in the case of Korea, where the old-age income security system is not sufficiently established and the elderly provide excessive labor supply, an increase in social protection fiscal expenditure that reduces the labor supply of the elderly could have a positive impact on the economy.

Conversely, when the share of fiscal expenditure in the health sector increases by 1 percentage point, real GDP increases by 1.5%. This is because fiscal expenditure in the health sector improves the health status of the population, thereby increasing labor productivity. Increased labor productivity can contribute to improvements in real GDP.

It was also found that when the share of fiscal expenditure in general public administration, public order and safety, and economic affairs sectors increases, the employment rate decreases. Specifically, a 1 percentage point increase in the expenditure share in these sectors results in a decrease in the overall employment rate by 0.64 percentage points, 2.53 percentage points, and 0.14 percentage points, respectively. This is analyzed as a crowding-out effect, where limited economic resources are used by the government instead of the private sector, reducing private demand and thus employment.

Korea Ranks Among the Lowest in OECD for Total Fiscal Expenditure Relative to GDP

Meanwhile, an analysis of 34 OECD countries showed that Korea's total government fiscal expenditure as a share of GDP was 27.8%, which is 14.9 percentage points lower than the OECD average of 42.7%. This places Korea near the bottom (33rd) among the 34 countries. Compared to OECD member countries, Korea's fiscal expenditure shares were relatively high in defense (2.4%), economic affairs (5.6%), environmental protection (0.8%), and housing and community amenities (1.1%). Conversely, the shares were relatively low in general public administration (4%), social protection (4.7%), education (4.4%), public order and safety (1.1%), and health (3.0%). Over the past 20 years, Korea has maintained a relatively high share of fiscal expenditure in economic affairs and a relatively low share in social protection.

If Korea's sectoral fiscal expenditure shares were adjusted to the OECD average levels, an increase in social protection fiscal expenditure share (+9.9 percentage points) would reduce real GDP by 20.8%, according to the analysis. Conversely, an increase in health sector fiscal expenditure (+3 percentage points) would increase real GDP by 4.5% and labor productivity by 6%. Increases in fiscal expenditure shares in general public administration and public order and safety sectors would decrease the employment rate by 1.5 percentage points each. A decrease in the economic affairs fiscal expenditure share was found to somewhat reduce labor productivity.

Professor Kim stated, "If fiscal expenditure has sufficient positive effects on macroeconomic factors such as economic growth and employment expansion, it can actually help long-term fiscal soundness." However, he also cautioned, "Continuous fiscal expenditure in sectors with low macroeconomic effects will worsen fiscal soundness in the long term."

He added, "Changes in sectoral fiscal expenditure can unintentionally cause positive or negative macroeconomic effects in terms of growth, employment, and productivity. Considering these incidental macroeconomic effects, efficient budget allocation for fiscal expenditure by sector should be implemented."

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